Professional Level Options Module Advanced Taxation (South Africa) Thursday 10 December 2015 Time allowed Reading and planning: Writing: 15 minutes 3 hours This question paper is divided into two sections: Section A BOTH questions are compulsory and MUST be attempted Section B TWO questions ONLY to be attempted Tax rates and allowances are on pages 2 5 Do NOT open this question paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor. This question paper must not be removed from the examination hall. Paper P6 (ZAF) The Association of Chartered Certified Accountants
SUPPLEMENTARY INSTRUCTIONS 1. You should assume that the tax rates and allowances for the tax year 2015 will continue to apply for the foreseeable future unless you are instructed otherwise. 2. Calculations and workings need only be made to the nearest R. 3. All apportionments should be made to the nearest month. 4. All workings should be shown. TAX RATES AND ALLOWANCES The following tax rates and allowances are to be used in answering the questions. Year ended 28 February 2015/31 March 2015 Rebates Primary rebate R12,726 Secondary rebate (over 65) R7,110 Tertiary rebate (over 75) R2,367 Interest exemption Under 65 R23,800 Over 65 R34,500 Foreign dividend exemptions Fully exempt where 10% or more of the equity shares and voting rights are held. Fully exempt where received by a company from a foreign company resident in the same country as the recipient. To the extent of any controlled foreign company inclusions (net of applicable foreign tax). To the extent that the foreign dividend is from a company listed on the JSE. To the extent that the above do not apply: For individuals 25/40ths of the dividend is exempt For companies 13/28ths of the divided is exempt Medical rebate rates Single member Member plus one dependant Each subsequent dependant Additional medical expenses tax rebate R257 R514 R172 Persons 65 or older or persons younger than 65 if that person, their spouse or their child is a person with a disability: ((Medical contributions (medical aid contribution tax rebate x 3) + other qualifying medical expenses) x 33 3% Persons younger than 65: ((Medical contributions (medical aid contribution tax rebate x 4) + other qualifying medical expenses) as exceeds 7 5% of taxable income x 25% Trusts (other than a special trust) 40% Dividends tax 15% Companies Normal tax rate 28% Donations tax 20% Estate duty 20% Official rate of interest (assumed) 8% 2
Rates of normal tax payable by persons (other than companies) for the year of assessment ended 28 February 2015 Where taxable income: does not exceed R174,550 18% of each R1 of the taxable income exceeds R174,550 but does not exceed R272,700 R31,419 plus 25% of the amount over R174,550 exceeds R272,700 but does not exceed R377,450 R55,957 plus 30% of the amount over R272,700 exceeds R377,450 but does not exceed R528,000 R87,382 plus 35% of the amount over R377,450 exceeds R528,000 but does not exceed R673,100 R140,074 plus 38% of the amount over R528,000 exceeds R673,100 R195,212 plus 40% of the amount over R673,100 Tax rates for small business corporations for the year of assessment ended 31 March 2015 Where taxable income: does not exceed R70,700 Nil exceeds R70,700 but does not exceed R365,000 7% of the amount over R70,700 exceeds R365,000 but does not exceed R550,000 R20,601 plus 21% of the amount over R365,000 exceeds R550,000 R59,451 plus 28% of the amount over R550,000 Turnover tax rates for micro businesses for the year of assessment ended 28 February 2015 Where taxable turnover: does not exceed R150,000 Nil exceeds R150,000 but does not exceed R300,000 1% of the amount over R150,000 exceeds R300,000 but does not exceed R500,000 R1,500 plus 2% of the amount over R300,000 exceeds R500,000 but does not exceed R750,000 R5,500 plus 4% of the amount over R500,000 exceeds R750,000 but does not exceed R1,000,000 R15,500 plus 6% of the amount over R750,000 Car allowance Maximum vehicle cost for actual expenses R560,000 Fringe benefit (company car) Benefit percentage (where no maintenance plan exists) 3 5% Benefit percentage (where a maintenance plan exists) 3 25% General business reduction: Benefit value x business kms/total kms (as per logbook) Private fuel reduction: Private fuel (R) x private kms/total kms (as per logbook) Private maintenance reduction: Private maintenance (R) x private kms/total kms (as per logbook) Subsistence allowances Deemed expenditure for meals and incidental costs (per Government regulation) R335 per day (local travel) Deemed expenditure for incidental costs only (per Government regulation) R103 per day (local travel) Deemed expenditure for meals and incidental costs (foreign travel) (per published tables) will be supplied in the question where relevant 3 [P.T.O.
Common capital allowances New and unused manufacturing plant and equipment 40%/20%/20%/20% Used or leased manufacturing plant and equipment 20% each year for five tax years New or unused plant or machinery used for research and development (where it does not qualify for the research and development accelerated allowance) 50%/30%/20% Small business corporation manufacturing plant and equipment 100% Small business corporation (other assets) unless wear and tear provides a greater deduction 50%/30%/20% Wear and tear (based on Binding General Ruling 7) will be supplied in the question where relevant Manufacturing building allowance (unless seller s rate supplied) 5% New or unused commercial building (not a manufacturing building) 5% No deduction where another section of the Act applies to the building Where part of a building is acquired, 55% of the acquisition price is cost Where an improvement to the building is acquired, 30% of the acquisition price of the improvement is cost Research and development (R&D) expenditure 150% Capital gains tax Annual exclusion (while alive) R30,000 Annual exclusion (in year of death) R300,000 Primary residence exclusion R2,000,000 (where proceeds are R2 million or less, the full gain is excluded for the portion of the property used for domestic purposes as a primary residence) Inclusion rate (natural persons) 33 3% Inclusion rate (non-natural persons) 66 6% Time apportioned base cost formula: Y = B + [(P B) x N/(T + N)] P = R x B/(B + A) Where deductible enhancement expenditure has been incurred after the valuation date, the time apportioned base cost formulae change to: Y = B + [(P 1 B 1 ) x N/(T + N)] P 1 = R 1 x B 1 /(A 1 + B 1 ) 4
Travel allowance table for years of assessment commencing on or after 1 March 2014 Value of the vehicle (including value Maintenance added tax (VAT) but excluding Fixed cost Fuel cost cost finance charges or interest) R R p.a. c/km c/km 0 80,000 25,946 92 3 27 6 80,001 160,000 46,203 103 1 34 6 160,001 240,000 66,530 112 0 38 1 240,001 320,000 84,351 120 5 41 6 320,001 400,000 102,233 128 9 48 8 400,001 480,000 120,997 147 9 57 3 480,001 560,000 139,760 152 9 71 3 Exceeds 560,000 139,760 152 9 71 3 Note: Where reimbursement is based on actual business kilometres travelled and no other compensation is paid to such employees and the kilometres travelled for business does not exceed 8,000, the prescribed rate is R3 30 per kilometre. Tax rates of normal tax retirement lump sum benefits in respect of the year of assessment ended 28 February 2015 Where taxable portion of lump sum: does not exceed R500,000 Nil exceeds R500,000 but does not exceed R700,000 18% of each R1 over R500,000 exceeds R700,000 but does not exceed R1,050,000 R36,000 plus 27% of the amount over R700,000 exceeds R1,050,000 R130,500 plus 36% of the amount over R1,050,000 Tax rates of normal tax withdrawal lump sum benefits in respect of the year of assessment ended 28 February 2015 Where taxable portion of lump sum: does not exceed R25,000 Nil exceeds R25,000 but does not exceed R660,000 18% of each R1 over R25,000 exceeds R660,000 but does not exceed R990,000 R114,300 plus 27% of the amount over R660,000 exceeds R990,000 R203,400 plus 36% of the amount over R990,000 5 [P.T.O.
Section A BOTH questions are compulsory and MUST be attempted 1 Julius Hamilton is a resident of the Cayman Islands and a former South African national. The Cayman Islands levy no personal tax. Julius made a significant fortune through shareholdings in a number of multinational companies. He would now like to focus his attention on investments in South Africa and Africa in general. Julius has been approached by his good friend, Helen, who is a resident of South Africa. Helen has encouraged Julius to invest in a company she wishes to incorporate in South Africa, AfrInvest (Pty) Ltd ( Afri ). The intention is that this company will act as a holding company for investments in small trading companies operating elsewhere within Africa (excluding South Africa). Based on investment projections, Helen hopes that Afri will have gross income of around R7 million each year. Based on Helen s proposal, Julius would acquire 60% of the equity shares and voting rights of Afri on incorporation and Helen would acquire the remaining shares. Helen would be the executive director and Julius would only attend meetings of the board of directors when he happened to be in South Africa to check on his other interests. It is intended that Afri s company policy will be that all equity acquisitions made in African companies would be for between 20% and 51% of the equity shares and voting rights in such companies. A condition of investment would be that this equity acquisition would provide Afri with both a strategic stake and a seat on the board of directors of these companies. The plan is that Afri would also act as a provider of finance to the African companies in which it will hold an investment. For this purpose, Julius would loan Afri money at a fixed rate. Afri would then in turn loan money to the African companies at a rate of interest based on the risk presented by the loan. The loans would be denominated in the local currency of the borrower company. From time to time, Afri will provide management services and advice to the African companies in which it will hold an investment. Afri will recruit a number of South African employees to occupy seats on the director boards of the various companies in which Afri will have shareholdings and also to provide the managerial services (where required). These employees will only physically be in the other African countries for the board meetings and all management services and advice will be rendered from South Africa via teleconference, email and other electronic modes of communication. Julius is aware that all the relevant African countries levy a 20% withholding tax on interest and no withholding tax on dividends paid to non-residents. Some of the relevant African countries levy 10% withholding tax on payments for managerial services rendered to non-residents. South Africa does not have double tax conventions with the Cayman Islands or any of the African countries in which Afri will make share acquisitions. Julius has experience in tax matters internationally but has not had exposure to the South African tax environment. Therefore, he has a number of targeted questions with respect to Helen s proposed investment, both in relation to Afri and himself. Specific questions: (a) Julius has queried whether, from the perspective of Afri, there are any taxation issues he should be aware of with respect to the following areas: (i) Residence of Afri; (2 marks) (ii) Controlled foreign company (CFC) rules; (5 marks) (iii) Transfer pricing rules; (iv) Exchange differences; (11 marks) (1 mark) (v) Foreign tax credits; and (4 marks) (vi) Value added tax (VAT) on the management services and advice. (1 mark) 6
(b) Julius has heard that certain companies can elect to be a headquarter company and has raised the following queries: (i) (ii) Required: Whether Afri will qualify as a headquarter company and, if so, the procedure for making such an election; (3 marks) How being a headquarter company would impact on the tax advice given on the areas queried in (a). (4 marks) Draft a report in which you address the questions raised by Julius Hamilton. Note: The split of the mark allocation is shown against each of the queries raised. Professional marks will be awarded in question 1 for the overall presentation of the report and the effectiveness with which the information is communicated. (4 marks) (35 marks) 7 [P.T.O.
2 Phillip Letsimo is an entrepreneur and would like to start a business in Durban, South Africa. A friend of his, Rachel Sintu, has some money available for an investment into a business opportunity. Phillip and Rachel have, therefore, decided to go into business together. They are not certain as to the legal form their business should take and have approached you for tax advice. Specifically, they are uncertain whether they should form a partnership or a company. All the estimated figures below exclude value added tax (VAT). The business activity undertaken by Phillip and Rachel will be the dyeing of fabric exclusively for export to customers overseas (this is considered a process of manufacture by the Commissioner for the South African Revenue Service (SARS)). Initially, Phillip and Rachel have R2 million each to invest in the business in whatever form necessary. The turnover in the first year is expected to be R3,000,000, but there will be significant capital outlay in the first year in terms of equipment required for the dyeing process costing R300,000, a further R1,000,000 to acquire office equipment and R1,750,000 to acquire the raw (undyed) fabric from various suppliers. They also intend to install a standby generator (R200,000) to run the dyeing equipment in the event of any power failures to prevent any loss of orders. Closing inventory of undyed fabric at the end of the first year of assessment is estimated to be R230,000. The net profits before tax for accounting purposes in the first year has been estimated as R1,166,667. If no other allowances are available, the Commissioner for SARS permits wear and tear on the dyeing equipment over six years, office equipment over three years and generators over 15 years. Phillip and Rachel each already have separate, unincorporated, businesses in their personal capacities which each generate taxable income of R3 million and are, therefore, registered as VAT vendors. Phillip and Rachel have agreed that, if a partnership structure is used, they will share the profits in the ratio 50:50. If a company is formed, they will each hold 50% of the equity shares and the company will pay to them the maximum dividend. Phillip and Rachel are also considering the possibility of introducing money by way of loans as well as equity if a company structure is used. Phillip and Rachel are fairly sure that they wish to use a company structure due to the legal advantages of limited liability over a partnership. However, in order to enable them to make their final choice, they have approached you and asked you to undertake the following work for them: (a) (b) (c) (d) New business activity legal structure Calculate the overall tax payable in respect of the fabric dyeing business s first year of operation, based on the estimated figures provided above, if it is run: As a partnership; or alternatively As a standard company (not qualifying for any special tax incentives) and advise on the most favourable legal structure from a tax perspective based on your calculations. Value added tax (VAT) Explain the matters to be aware of in respect of VAT as a result of the new fabric dyeing business activity and whether these will differ depending on which legal structure is used. Loan financing company Assuming that Phillip and Rachel decide to operate the new fabric dyeing business through a standard company (not qualifying for any special tax incentives): Explain the tax advantage of Phillip and Rachel introducing the majority of their capital into the business by way of loan finance (debt) rather than equity. Special tax incentives company Assuming that Phillip and Rachel decide to operate the new fabric dyeing business through a company: Explain any special tax incentive available and outline the associated qualifying conditions; Explain, with the aid of supporting calculations, the reduction in the total tax payable for the first year of the business operations if this relief were to apply. 8
Required: Carry out the work required as requested by Phillip and Rachel above. The following marks are available: (a) (b) (c) New business activity legal structure. Note: You are not required to consider value added tax (VAT) as part of your answer to part (a). Value added tax (VAT). Loan financing company. (10 marks) (3 marks) (3 marks) (d) Special tax incentives company. (9 marks) (25 marks) 9 [P.T.O.
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Section B TWO questions ONLY to be attempted 3 GenCo Ltd is a company resident in South Africa and is a registered value added tax (VAT) vendor. The company has approached you to request advice on the VAT implications of several transactions it has entered into. GenCo Ltd imports diesel-powered generators from China to supply to both residential and commercial customers in South Africa as well as to export to customers in the rest of Africa. GenCo Ltd is a subsidiary of DieselWorld Ltd, a resident of Ireland. The group s manufacturing subsidiary is located and tax resident in China. The directors of GenCo Ltd have asked you for advice regarding a number of transactions entered into during the year ended 31 March 2015. The amounts below exclude VAT unless otherwise stated. Sales of generators GenCo Ltd sold a number of generators to customers located outside South Africa. Such sales take two forms: (a) the generator is purchased by GenCo Ltd and imported into South Africa. GenCo Ltd then pays a South African transport company to deliver the generator to the customer s address outside South Africa; or (b) the generator is purchased by GenCo Ltd and imported into South Africa. It is then sold to the overseas customer who arranges to collect the generator themselves from GenCo Ltd s South African warehouse. During the year, the company made type (a) sales amounting to R13 million and type (b) sales amounting to R4 million. In addition, GenCo Ltd made sales to local customers in South Africa amounting to R23 million. Of these sales, 30% were to non-vat vendor customers and the remaining 70% of these sales were to VAT vendor commercial customers. (5 marks) Delivery costs Delivery costs paid to a delivery company in South Africa relating to type (a) sales to overseas customers amounted to R250,000 and those relating to sales to local customers in South Africa amounted to R600,000. (3 marks) Imports of generators Generators were imported from the group manufacturing subsidiary in China at a cost of R27 million with a declared customs value of the same amount. The import duty on generators is nil. (3 marks) Financial services division To provide financial support to customers as a result of the high cost of the generators, GenCo Ltd set up a financial services division on 1 April 2014. The interest income arising from the financial services amounted to R6 million which accounts for 13% of GenCo Ltd s total turnover for the year ended 31 March 2015. It is anticipated that this proportion will remain constant in the future. GenCo Ltd estimates that 20% of the premises it rents is used for staffing the financial services division. The annual rental of the premises is R280,000. During the year, all of the computers which had previously been used exclusively to process sales of generators had to be adapted to also be able to process financial services transactions. The computers had originally cost R300,000 when acquired and cost a further R50,000 to adapt to deal with the financial services transactions. The computers have a current market value of R250,000. In addition, new computers were purchased during the year to be used exclusively in the financial services division at a cost of R100,000. A motor car originally purchased for the director of sales was transferred during the year for the use of the new director of the financial services division. The motor car had originally cost GenCo Ltd R450,000 in June 2013. The transfer took place on 1 April 2014. (9 marks) Required: Advise GenCo Ltd as to the value added tax (VAT) implications of the above transactions. Your answer should include supporting calculations, where relevant. Note: The split of the mark allocation is shown against each of the transactions above. (20 marks) 11 [P.T.O.
4 You should assume that today s date is 1 January 2015 You have been approached by Sipho Sicamba for advice on the likely tax implications on his death and on any recommended estate planning. Sipho is aged 40 years and has a wife who is aged 37. The couple have two minor children aged three and one years. Sipho is concerned that his will is not up-to-date. His last will simply leaves his entire estate to his wife out of community of property. Sipho has already amassed a large estate. Details of his assets and liabilities are listed below: Assets and liabilities (i) The family home which originally cost R3 million in 2008 and now has a market value of R5 8 million. There is a mortgage bond still over the property amounting to R1 5 million. The property is registered in both Sipho and his wife s name but the mortgage is registered in his name only. (ii) (iii) (iv) (v) (vi) A motor vehicle which cost R450,000 when acquired in November 2013. There is no amount owing on this vehicle. The market value of the vehicle is R405,000. A fixed hull 7-metre rubberduck boat purchased second-hand for R70,000. The market value of the boat is R65,000. Furniture and other personal effects with a total current market value of R1 million. A provident fund accumulation account (held in an employer contributing provident fund) of R2 million. Retirement annuity funds of R1 million. (vii) A life insurance policy with a value of R7 million with premiums paid by Sipho. (viii) Private collective investment scheme investments currently valued at R500,000 for which contributions of R350,000 have been made. (ix) A joint bank account with his wife held with an overseas bank and denominated in a foreign currency. The bank account has a current market value of R250,000. Apart from his wife and minor children, Sipho has no other factual or legal dependants. Sipho wants to make sure that his will makes adequate provision for his family; ensures that his estate is sufficiently liquid to cover any liabilities and expenses on his death; and is structured to ensure that the minimum estate duty and income tax is payable at his death. His bank is the current executor under his will and will levy a fee for executor s services of 3% of the gross asset value of the estate at the time of his death. As Sipho s wife is independently employed, he has indicated that she would likely accept a payment by way of a lump sum from any provident and retirement annuity funds held by Sipho on his death. Employment Sipho currently earns a salary of R640,000 per annum from his employer. His employer makes contributions to the provident fund of R160,000 per annum. Sipho does not make any contributions to the provident fund. Costs on death It has been estimated that, on Sipho s death, the miscellaneous expenses, Master s fees, conveyancing fees and other legal costs would amount to R200,000. Sipho s funeral expenses have been estimated at a further R100,000. 12
Required: (a) (b) (c) Calculate the normal income tax and estate duty liabilities if Sipho were to die on 28 February 2015 and explain the mechanism for payment of these liabilities. Note: You should clearly indicate items which do not impact on the calculation of the tax liability by the use of zero (0). (6 marks) Determine whether or not Sipho s estate would have sufficient cash to settle all liabilities payable on his death assuming he were to die on 28 February 2015. (4 marks) Explain the operation of each of the following planning proposals in respect of Sipho s estate, commenting on the potential tax advantages/disadvantages they offer and their suitability for Sipho: Leaving the current will unchanged; The creation of an inter vivos trust; The creation of a testamentary trust. Note: You should assume that the date of Sipho s death is, as yet, unknown in your answer to this part. (10 marks) (20 marks) 13 [P.T.O.
5 (a) You should assume that today s date is 15 March 2014 Anton du Toit is a non-resident of South Africa and is planning to purchase the equity and loan capital of a company. Related to this acquisition, he requires your advice on residency issues and the rules governing the use of a brought forward assessed loss by a company. Anton is resident in Bermuda where there is no income tax. He has identified a South African company, ABC (Pty) Ltd, which has been producing a product, StarBright, and over the last few years has generated an assessed loss of R2 million due to a declining market for StarBright. Anton has a controlling interest in XYZ Co, a company resident overseas which produces a related product, MoonBright. XYZ Co is highly profitable due to a growing market for the MoonBright product. Anton intends to acquire all the shares in ABC (Pty) Ltd on 1 April 2014 and change its trade to that of a distributor of MoonBright products. It is estimated that, if Anton s plan goes ahead during the year of assessment ended 31 March 2015, ABC (Pty) Ltd will realise taxable profits of R7 million. ABC (Pty) Ltd is currently a family run company and, as a result, has a small amount of equity capital and is heavily geared through loans from the family member shareholders. All of the family member shareholders of ABC (Pty) Ltd are South African residents. Anton will acquire both the equity shares and loan receivable accounts of ABC (Pty) Ltd from the family members. Initially, Anton intends that the day-to-day running of ABC (Pty) Ltd will take place in South Africa. To achieve this, Anton plans to be in South Africa for the first 180 days of the first financial year to ensure the effective running of the company. Thereafter, Anton intends to return to Bermuda from where all strategic decisions and directors meetings of ABC (Pty) Ltd will then be conducted. In case he is required to spend more time in South Africa, Anton would like to understand the tax implications of him spending further time in South Africa. Anton is aware of the potential transfer pricing exposure and does not require your advice on this matter. Required: Assuming that the acquisition by Anton du Toit of ABC (Pty) Ltd goes ahead on 1 April 2014 as intended: (i) (ii) Advise Anton on whether the R2 million of assessed losses in ABC (Pty) Ltd may be used against the estimated taxable profits for the year of assessment ended 31 March 2015. (5 marks) Discuss the current and future residence status of both ABC (Pty) Ltd and Anton and explain the tax implications if Anton were to become South African resident. (5 marks) (iii) Explain the income tax consequences for Anton as a result of his acquisition of all of the equity shares and loan receivable accounts of ABC (Pty) Ltd and advise whether it is preferable from a tax perspective for Anton to increase his equity investment and reduce his investment in loan receivable accounts. (5 marks) (b) Anton also wishes to invest in a venture capital company to assist start-up entities. He has identified an opportunity with VentureSA Ltd whereby he will subscribe for 5% of the equity shares in VentureSA Ltd for R5 million. VentureSA Ltd meets the definition as a qualifying company under the relevant legislation. Anton is unsure whether he should finance this acquisition through a bank loan repayable in seven years or in cash. Required: (i) (ii) Discuss the immediate tax implications of the investment in the venture capital company by Anton, commenting on whether it would be preferable from a tax perspective for him to subscribe for the shares in cash or take out a bank loan. (3 marks) Outline the four conditions which must be met for the Commissioner of the South African Revenue Service (SARS) to approve a company as a venture capital company. (2 marks) (20 marks) End of Question Paper 14