Professional Level Options Module Advanced Taxation (South Africa) Friday 6 June 2014 Time allowed Reading and planning: Writing: 15 minutes 3 hours This 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 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 2014 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 2014/31 March 2014 Rebates Primary rebate R12,080 Secondary rebate (over 65) R6,750 Tertiary rebate (over 75) R2,250 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 R242 R484 R162 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% Rates of normal tax payable by persons (other than companies) for the year of assessment ended 28 February 2014 Where the taxable income Does not exceed R165,600 18% of each R1 of the taxable income exceeds R165,600 but does not exceed R258,750 R29,808 plus 25% of the amount over R165,600 exceeds R258,750 but does not exceed R358,110 R53,096 plus 30% of the amount over R258,750 exceeds R358,110 but does not exceed R500,940 R82,904 plus 35% of the amount over R358,110 exceeds R500,940 but does not exceed R638,600 R132,894 plus 38% of the amount over R500,940 exceeds R638,600 R185,205 plus 40% of the amount over R638,600 2
Tax rates for small business corporations for the year of assessment ended 31 March 2014 Where taxable income: does not exceed R67,111 Nil exceeds R67,111 but does not exceed R365,000 7% of the amount over R67,111 exceeds R365,000 but does not exceed R550,000 R20,852 plus 21% of the amount over R365,000 exceeds R550,000 R59,702 plus 28% of the amount over R550,000 Turnover tax rates for micro business corporations for the year of assessment ended 31 March 2014 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 R480,000 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) R319 per day (local travel) Deemed expenditure for incidental costs only (per Government regulation) R98 per day (local travel) Deemed expenditure for meals and incidental costs (foreign travel) (per published tables) will be supplied in the question where relevant 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 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 100% Additional 50% on expenditure incurred if R&D project is approved by the Minister of Science and Technology and incurred for R&D after such approval 3 [P.T.O.
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 ) Travel allowance table for years of assessment commencing on or after 1 March 2013 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 60,000 19,310 81 4 26 2 60,001 120,000 38,333 86 1 29 5 120,001 180,000 52,033 90 8 32 8 180,001 240,000 65,667 98 7 39 4 240,001 300,000 78,192 113 6 46 3 300,001 360,000 90,668 130 3 54 4 360,001 420,000 104,374 134 7 67 7 420,001 480,000 118,078 147 7 70 5 Exceeds 480,000 118,078 147 7 70 5 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 24 per kilometre. 4
Tax rates of normal tax retirement lump sum benefits for the year of assessment ended 28 February 2014 Where taxable portion of lump sum: does not exceed R315,000 Nil exceeds R315,000 but does not exceed R630,000 18% of each R1 over R315,000 exceeds R630,000 but does not exceed R945,000 R56,700 plus 27% of the amount over R630,000 exceeds R945,000 R141,750 plus 36% of the amount over R945,000 Tax rates of normal tax withdrawal lump sum benefits for the year of assessment ended 28 February 2014 Where taxable portion of lump sum: does not exceed R22,500 Nil exceeds R22,500 but does not exceed R600,000 18% of each R1 over R22,500 exceeds R600,000 but does not exceed R900,000 R103,950 plus 27% of the amount over R600,000 exceeds R900,000 R184,950 plus 36% of the amount over R900,000 5 [P.T.O.
Section A BOTH questions are compulsory and MUST be attempted 1 You are the tax manager of Course-to-go (Pty) Ltd (CTG), a company which offers online training courses on various subjects in South Africa. Due to personal circumstances, one of CTG s full-time employees, Mrs Kumalo, approached the financial director in May 2013 about the need to reduce her working hours. Mrs Kumalo is highly valued by the company and in order to retain her services the following terms were agreed by the financial director, on behalf of CTG, with effect from 1 June 2013: (1) CTG would pay Mrs Kumalo a monthly retainer of R15,000. (2) She would, in addition, charge CTG an hourly rate of R400 per hour. (3) She would work from home and invoice CTG for the actual time spent by the 20th of each month. (4) The specific work to be completed by her and the timescale would be pre-approved by the relevant course managers. Progress reports are required at the end of each month for any work in progress. (5) CTG would pay for a high speed fixed internet line to be installed at Mrs Kumalo s home to provide her with remote access to CTG s servers. The fixed line installation cost would be R780 and the monthly fee (also to be paid by CTG) would be R1,140. The line would be monitored by CTG and may only be used for business purposes. (6) The work completed by Mrs Kumalo would be reviewed by the relevant course managers. The invoiced hours have to be approved by the relevant course managers to confirm that the pre-approved work was completed to a satisfactory level before payment is made. If the work is unsatisfactory, the invoiced hours are not paid by CTG and Mrs Kumalo has to repeat the work to the required level. (7) As the work she currently performs is internet based, from a customer perspective there would be no noticeable difference as a result of the new arrangements or the reduced working hours required (i.e. less than a full-time position would require). (8) CTG would pay Mrs Kumalo a one-off restraint of trade lump sum of R50,000 to prevent her working for any competitor for a period of three years. Mrs Kumalo billed the following hours of work in the first nine months of the new arrangements: Month Hours worked June 2013 30 July 2013 40 August 2013 20 September 2013 25 October 2013 45 November 2013 38 December 2013 12 January 2014 0 February 2014 30 Following the implementation of the new arrangements, CTG has not withheld employees tax on any payments made to Mrs Kumalo. The financial director has now become concerned about these arrangements and has approached you with the following: (i) (ii) Whether CTG s treatment of Mrs Kumalo under the new arrangements, in particular the decision not to withhold any employee s tax, is correct. (19 marks) Assuming that employee s tax should have been withheld, whether CTG is likely to be subject to any tax penalties with respect to their treatment of Mrs Kumalo and the action (if any) CTG might take to mitigate their position. (8 marks) (iii) What the tax implications for CTG are with respect to the one-off restraint of trade payment made to Mrs Kumalo. (4 marks) 6
Required: As the tax manager of Course-to-go (Pty) Ltd provide a report to the financial director which answers his questions with respect to the treatment of Mrs Kumalo. Note: The mark allocation is shown against each of the three questions. 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 The financial director of TyreCo Ltd (TCO) has come to you with two specific tax queries pertaining to the 2014 year of assessment. TCO has a financial and tax year of assessment ending on 31 March each year. TCO is a value added tax (VAT) vendor, but all the amounts referred to below are stated excluding VAT. The VAT has been separately and correctly calculated by the indirect tax specialist on your team. Query 1 TCO purchased a wheel suspension testing machine on 1 June 2001 for R350,000. Wheel suspension testing is not a process of manufacture, but the Commissioner for the South African Revenue Service (SARS) agreed the period for wear and tear on the machine as five years from the date of purchase. There is no residual value for the machine. On 31 March 2011, the gearbox of the machine failed and had to be replaced. The cost of the replacement gearbox was R40,000. Due to advances in technology, the new gearbox vastly improved the performance of the machine and the Commissioner for SARS did not permit a deduction of the cost of the gearbox as a repair, but did accept that the gearbox was a depreciable improvement. The wear and tear on a gearbox can be obtained from Binding General Ruling 7, which indicates a period of six years. The new gearbox was installed on 1 April 2011. On 1 April 2013, TCO sold the machine for its then market value of R400,000. The selling price of the machine was high because significant value remained in the advanced nature of the gearbox installed. No valuation was performed on 1 October 2001. The sale proceeds helped to fund the purchase of a replacement machine, which was acquired and installed at a cost of R540,000 on 1 July 2013. This replacement machine will also qualify for a write-off period of five years, with no residual value. TCO has an assessed capital loss brought forward from the 2013 tax year of R50,000. TCO s bookkeeper is not sure as to whether any tax will be payable with respect to the disposal of the machine on 1 April 2013 or the income tax effects with respect to the machine acquired on 1 July 2013. The financial director has asked that you provide him with detailed calculations, together with relevant explanations, of the tax consequences of the disposal on 1 April 2013 and of any tax effects arising from the purchase on 1 July 2013. Also, if any elections can be made to minimise the tax payable, that you indicate the options which could apply. (15 marks) Query 2 TCO imported another machine which would deflate air-filled tyres and re-inflate them with nitrogen for better tyre performance. At the same time, the machine would pressure test the tyres and spots for repair would be marked for the technician to repair before the tyre is reinserted into the machine. The machine s original cost on 1 March 2009 was R450,000. The Commissioner for SARS agreed the period for wear and tear of the machine to be five years, with no residual value. At full capacity the machine can process 480 tyres per working day (i.e. one tyre per minute). However, the machine did not generate the anticipated business for TCO and so was sold. The purchaser of the machine, AmCO Tyres (AmCO), is also unsure of the machine s possible success in its business and so TCO and AmCO have agreed that TCO will sell the machine for a R300,000 initial payment and R60,000 per year in each of the next five years if the machine processes at least 32,000 tyres per year (i.e. no payment is made in a particular year if the machine does not meet that year s target). The sale agreement was entered into on 1 March 2011. The machine missed the processing target in both the 2012 and 2013 years of assessment but met the target in the 2014 year of assessment. The financial director tells you that while the arrangement seems like a good business decision, he is uncertain as to how to account for the capital gains tax on the disposal of this machine. He wants you to explain when the disposal takes place and how to account for the proceeds, and to provide him with supporting calculations for each year of assessment since the disposal took place. (10 marks) 8
Required: Answer the financial director s questions for both Query 1 and Query 2. Note: The mark allocation is shown against each of the queries. (25 marks) 9 [P.T.O.
Section B TWO questions ONLY to be attempted 3 John Paddock has approached you for advice concerning estate planning. Mr Paddock who is 50 is a man of considerable wealth. He has a wife, Samantha, aged 40 and two children aged 15 and 12 years. Most of John s wealth is in South African property and South African equity investments. He estimates that his property investments have a market value of R20 million and his equity investments are worth R10 million. Unfortunately, John suffers from poor health and he wishes to set up a plan which will both provide security for his family as well as minimise any tax liabilities. A number of possibilities exist: (i) Donate all of his assets to his wife. (5 marks) (ii) Donate a usufruct in his assets to his wife and retain the bare dominion. The bare dominion will then be left to his two children in his will. (5 marks) (iii) Form a trust in which his wife and children are beneficiaries and either donate or sell his assets directly to the trust. (7 marks) (iv) Form a trust (as in (iii)) but only donate a small amount to the trust. Once created the trust will form a company, in which the trust will hold 100% of the ordinary shares and John will acquire 100% of the non-participating preference shares. The preference shares will have voting rights slightly in excess of the ordinary shareholder voting rights. The assets will then be acquired from John by the company on loan account at the assets market values. (3 marks) Required: Advise John Paddock on the estate duty, donations tax, capital gains tax and other income tax aspects of each of his four proposals. Where relevant, include reference to the tax positions of his wife and children and identify the most beneficial option(s). Note: The mark allocation is shown against each of the options. (20 marks) 10
4 Man Co Ltd (Man Co) is a South African company carrying on business in Johannesburg, South Africa. The company manufactures various goods for sale to retailers. Man Co is a registered value added tax (VAT) vendor. Man Co is considering opening a branch in the Western Cape (in South Africa). To do this, it would need to either lease or purchase land. Three options are available as follows. All figures are stated inclusive of VAT, where applicable. Option 1 Man Co can purchase land with a building thereon from a non-vendor for R25 million. The building has been standing vacant for many years and the seller has not been able to claim any allowances. Transfer duty of R1,917,000 will be payable on the transfer to Man Co. Option 2 Man Co can purchase an existing factory building for R30 million from Boy Co Ltd (Boy Co). Boy Co is a connected person of Man Co and a vendor for the purposes of VAT. Boy Co has claimed a 5% allowance on the building, which had cost them R9 million and has always been used in a manufacturing process. Man Co would have to make certain improvements to the building amounting to R2 million to accommodate the machinery they would need to acquire. Option 3 Man Co can lease a piece of land for 25 years from a VAT vendor. In terms of the lease, Man Co will have to erect a factory building on the land costing at least R30 million. Man Co estimates the cost of erecting the building as R35 million and that the building would take nine months from the inception of the lease to complete. The lease rental is R90,000 per month. In terms of the lease, Man Co would also have to pay an up-front premium of R50,000. Required: (a) (i) Explain the value added tax (VAT) and income tax implications arising in respect of each of the three options, giving supporting calculations where the information permits. (12 marks) (ii) Explain the income tax implications for the lessor in the case of option 3. (4 marks) (b) Explain the VAT implications for Man Co if, in addition to its South African operations, it also sells goods through a branch it operates outside South Africa. (4 marks) (20 marks) 11 [P.T.O.
5 Mrs Poor (a South African resident) has recently inherited a large sum of money (R9 million) from her late father s estate. She has approached you for assistance with the investment of this money. She is concerned about the value of the rand against the US dollar and British pound. Mrs Poor would like to invest the maximum permissible amount offshore and only invest the balance locally. All investments will be made directly, as Mrs Poor does not wish to use a trust. Whether offshore (foreign) or local, Mrs Poor would like 50% of her investments to be in shares, 30% in immovable property and 20% in bonds (cash). Mrs Poor s husband is not a wealthy person and Mrs Poor is quite happy to give some of the money to him if it is necessary to better facilitate her investment plans. Mrs Poor has never had this sort of wealth previously and therefore has little knowledge of financial matters and she has never invested in equities before. Required: Set out the specific tax issues relevant to Mrs Poor s investment proposals. Note: The current Reserve Bank regulations permits each South African resident to invest a maximum of R4 million offshore. (20 marks) End of Question Paper 12