Professional Level Options Module, Paper P6 (ZAF)

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2 Professional Level Options Module, Paper P6 (ZAF) Advanced Taxation (South Africa) December 2013 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 Op Co (Pty) Ltd/Hold Co (Pty) Ltd/Mr Shane Dealer ABC Tax Consultants Address Cape Town South Africa Mr Dealer Address Cape Town South Africa 6 December 2013 Dear Mr Dealer E: QUEIES PETAINING TO THE LIQUIDATION OF THE HOLD CO (PTY) LTD GOUP This letter serves to provide the explanations you have requested. Each question has been considered in turn below. General comments To determine the amount you are to receive and to determine your income tax effects, the consequences of the liquidation of the group must first be assessed. (i) The amount receivable in cash on completion of the liquidations Op Co (Pty) Ltd (OCPL) At the start of its financial year this operating company had no liabilities. However, the company s trading activities in the period 1 April to 30 September 2012 will have generated income tax and value added tax (VAT) effects and it must first be determined whether or not a liability for tax arises from these transactions. Income tax consequences Not only must the trading effects be taken into account, but also the income tax effects arising from the transactions of the liquidator. However, two transactions are unlikely to have an effect on the taxable income of OCPL. First, the severance packages paid to employees are submitted to be not in production of income. As the company will be entered into liquidation proceedings, there is no intent to produce further income. It is therefore submitted that this amount is not deductible in terms of the general deduction provision. Second, the liquidation costs incurred are submitted to be of a capital nature and, as a result, are not deductible for income tax. Further, neither the severance packages nor the liquidation costs relate to an asset for the purposes of capital gains and therefore no capital gains tax consequences can arise as a result of these two costs. The income tax liability due to the South African evenue Service (SAS) for the 2013 year of assessment is therefore 336,000 (see Appendix, Schedule 1 for detailed computation). The VAT liability for the period 1 April 2012 to the conclusion of OCPL s liquidation will have been 197,400 (see Appendix, Schedule 2 for detailed computation). The assets of OCPL (after the settlement of the liabilities) will equal the equity. As shown by the cash flow summary in the Appendix, Schedule 3, this will be 9,524,000. This is the amount distributable to Hold Co (Pty) Ltd (HCPL). The capital originally introduced of 2,500,000 represents the contributed tax capital of OCPL and as such can never be a dividend. The dividend arising on liquidation is therefore 7,024,000 (being 9,524,000 less 2,500,000). As this dividend is payable to HCPL, a resident company, the dividend payment will be exempt from dividends tax. HCPL will therefore receive 9,524,000 of which 7,024,000 is a dividend. Hold Co (Pty) Ltd (HCPL) HCPL does not trade, but is merely a legal vehicle to hold the investment in OCPL. Therefore, no income tax liability will arise as: (1) The dividend received from OCPL will be exempt from normal tax. (2) The liquidation costs are of a capital nature and therefore not deductible (nor qualify for capital gains tax purposes). (3) The proceeds for the purposes of capital gains tax will be 2,500,000 less the base cost, being the originally contributed amount of 2,500,000 resulting in no capital gain or capital loss arising. HCPL is also not a VAT vendor, so no VAT consequences need be considered. 15

3 As no liabilities exist within HCPL, its assets at liquidation will match its equity, being: Cash at 1 April ,000,000 Add: Amount received from OCPL 9,524,000 Less liquidation costs (11,400) Cash = Equity remaining 10,512,600 Again, the capital originally introduced of 500,000 represents the contributed tax capital of HCPL and as such can never be a dividend. The dividend arising on liquidation is therefore 10,012,600 (being 10,512,600 less 500,000). As this dividend is payable to a natural person, no dividends tax exemptions are applicable, so dividends tax of 15% must be withheld by HCPL on the shareholder s (your) behalf. Dividends tax of 1,501,890 will therefore be withheld. You will therefore receive 9,010,710 (being 10,512,600 less 1,501,890). However, the full 10,512,600 accrues to you of which 10,012,600 is a dividend (and is exempt from normal tax). (ii) The deduction for the shares acquired in Hold Co (Pty) Ltd (HCPL) The deduction in respect of the purchase price of your shares in HCPL will be limited by the Commissioner of SAS as a result of the acquisition being with the intent to liquidate the group and your status as a sharedealer. Essentially, as you acquired the shares with the intent to liquidate the company, you have purchased the contributed tax capital and an exempt dividend. As no deduction is permitted for expenses which produce exempt income, the purchase price must be apportioned between the amount used to acquire the contributed tax capital and the portion used to acquire the exempt dividend. The most appropriate basis of apportionment would be the contributed tax capital divided by the total equity before the liquidation distribution. This means that of the purchase price of 4,000,000, only 190,248 will be permitted as a deduction (being 4,000,000 x 500,000/10,512,600). Tutorial note: This apportionment arises from the tax case of Nemojim. It is based on the application of s.11(a) read with s.23(f) of the Income Tax Act. (iii) The effect of the liquidation on your taxable income The full amount accruing to you on the final liquidation of HCPL falls into your gross income, i.e. 10,512,600. Of this amount, 10,012,600 is exempt from normal tax as the liquidation dividend. The net result, after deducting the allowable portion of the purchase price of HCPL Ltd, will result in additional taxable income of 309,752 (being 500,000 less 190,248). Aggregated with your other trading profits, your total taxable income for the 2013 year of assessment will be 10,309,752. No capital gains tax arises as you held the shares in HCPL with a revenue intention. Should you require any further information in relation to these or any other queries, please do not hesitate to contact us. Yours sincerely ABC Tax Consultants 16

4 APPENDIX Schedule 1: OCPL income tax liability for the 2013 year of assessment Sales 2,000,000 Employment related costs (750,000) unning costs (while trading) (450,000) Wear and tear on fleet vehicles (790,000) Bad debt write off (by liquidator) net of VAT 114,000 x 14/114 (100,000) ecoupment on disposal of fleet vehicles (Selling price limited to cost) less tax value 6,000,000 less (5,500, ,000) 1,290,000 Capital gains tax Consideration (VAT was at the zero percent) 6,000,000 Less recoupment (1,290,000) Proceeds 4,710,000 Less base cost: 4,710,000 Being: Expenditure 7,000,000 Less allowances to date of disposal (7,000,000 5,500, ,000) (2,290,000) Capital gain/capital loss 0 No capital gains or capital losses arise, so there is no inclusion 0 Taxable income 1,200,000 Tax at 28% 336,000 Schedule 2: OCPL VAT for the period 1 April 2012 to the conclusion of its liquidation Input Output Sales 2,000,000 x 14% 280,000 Employment services not charged to VAT 0 unning costs 450,000 x 14% 63,000 Bad debt claw back of output VAT 114,000 x 14/114 14,000 Liquidation costs 45,600 x 14/114 5,600 Disposal of fleet (zero rate) 0 82, ,000 VAT liability 197,400 Schedule 3: OCPL cash flow summary for the period 1 April 2012 to the conclusion of its liquidation Cash opening balance at 1 April ,500,000 Add: Sales income 2,000,000 x 114/100 including debt 2,280,000 Debt not collected (114,000) 2,166,000 Proceeds on sale of the vehicle fleet 6,000,000 Less: Employment costs (while trading) (750,000) Severance payments (300,000) Other running costs (while trading) 450,000 x 114/100 (513,000) Liquidation costs (45,600) Less income tax (Schedule 1) (336,000) Less VAT (Schedule 2) (197,400) Cash = Equity remaining 9,524,000 17

5 2 James Ncayiyana (a) Tax efficient creation of the JN Trust James should set up the trust by means of a loan to the trust of 300,000 made in cash. As a loan is not a gift donations tax will be avoided. Further, the loan of cash will not have any capital gains consequences as local currency is not an asset for the purposes of capital gains tax, so no disposal of an asset arises. In order to avoid any adverse donations tax consequences arising from the charging of a low interest rate between connected persons, the loan agreement should not make any reference to interest or to repayment terms. An interest free loan is, however, a disposition for the purposes of the anti-avoidance rules in (b) below. Tutorial note: While a trust may be created by verbal agreement, it is best if reduced to writing in a document called the Trust Deed. There is no need for this document to be notarially executed, but this may assist to ensure the validity of the trust deed. It is recommended that the trust and trustees be given the widest powers to ensure flexibility of the trust in subsequent years. It is further recommended that the trust be formed with three trustees (at least one of whom should be independent) to ensure that the assets in the trust are not deemed to be those of the deceased (in the event of the creation of an inter vivos trust) for estate duty purposes. (b) (i) Income tax implications for James and the JN Trust For an inter vivos trust during the continued life of the founder (donor), the trust s income and capital gains are subject to specific anti-avoidance attribution rules. These rules, in short, provide that in the case of income: (1) income accumulated or distributed to a minor child arising from a donation, settlement or other disposition from a parent, will be taxed in that parent s hands; (2) income retained (i.e. not vested in a beneficiary) in the trust will revert to the donor of the assets giving rise to the income; and (3) income vested in a non-resident by virtue of the donation, settlement or other disposition by a resident will be taxed in that resident s hands. Similar provisions and effects arise in the case of capital gains arising on assets donated, settled or arising from some other form of disposition in the trust. However, only capital gains may be attributed to the donor and not capital losses. Anti-avoidance measure (1) applies irrespective of whether a trust is a vesting or a discretionary trust. Therefore, any income accumulated on behalf of or distributed to James s children while they are still minors will be taxed in James s hands; as well as any capital gains arising in the Trust for such children. The measure in (2) cannot apply to the JN Trust, as the Trust is fully vesting to the beneficiaries as regards income. In such circumstances even if amounts are retained within a trust, the trust itself has no vested right to such monies but is merely managing the amounts on behalf of the vested beneficiaries. James may, however, be taxed on any capital gains arising to the extent that they have not already been caught and taxed in his hands under measure (1). The measure in (3) is not relevant to the JN Trust as none of the intended beneficiaries is a non-resident. Despite James having the broad capital intent principle of creating the Trust for the future benefit of his wife and children, the basis on which he wishes the trustees to approach the equity share investments (i.e. the maximisation of profit) will result in the share transactions being of a revenue nature. However, any qualifying share held for more than three years will be deemed (in terms of the Income Tax Act) to be held with a capital intention. To avoid having the proceeds included in gross income, the trustees should direct the investment managers to invest in shares expected to yield long-term capital growth, so that the disposals will generally be in excess of the three-year holding period for this deemed capital intention and so qualify for the more favourable capital gains tax treatment where a gain arises. The Trust will only be able to deduct the investment manager fees against taxable profits arising from the sale of the equities, not against the receipt of exempt dividends. (ii) Estate duty implications on James s death If the JN Trust is created by means of a loan (rather than by a donation), then unless it is repaid by the Trust prior to James s death, the loan (or any balance not repaid) will remain as an asset in James s estate in terms of the Estate Duty Act. James s will provides that the remainder of his estate is to be left to his spouse. The value left to his spouse is treated as a deduction from the gross value of the estate for estate duty purposes. The result, based on the information supplied, will be that the only amount left in James s net estate would be the loan account asset. The net value of an estate is reduced by the abatement of 3,500,000, so in this case, the abatement would reduce the 3,000,000 to nil and no estate duty would arise. (c) Income tax implications of making the Trust fully discretionary post creation The vested right to the income will be an asset for capital gains tax purposes for each beneficiary. A change to the trust deed removing such a vested right and replacing it with only a discretionary right to income would generate a capital gains tax disposal event. The resulting capital gain or capital loss will have to be recognised by the relevant beneficiary. Further, given 18

6 the anti-avoidance rules (as referred to in (b)(i) above), if his children are still minors when the change is made, it is James who will be taxed on any capital gain arising. (d) (i) Estate duty consequences if James is one of the trustees Provided James does not retain control over the assets (by virtue of being the sole or a controlling trustee), the JN Trust assets will not be deemed to be his in terms of the Estate Duty Act. (ii) Estate duty consequences if James is one of the beneficiaries If James is a vested beneficiary of the JN Trust as regards capital, then that portion of the Trust assets for which he is a beneficiary will be included in his estate, increasing the value of the estate for estate duty purposes. This would not be efficient or effective from an estate duty perspective, as, if the loan was still outstanding, it would effectively result in an element of double counting and even if the loan had been repaid, partially negate the benefit of creating the Trust. In addition, the vesting of income on James during his lifetime would also serve (to the extent it is not spent on consumables) to increase the value of his estate on death, whether the income is retained in cash or used to buy other assets. 3 Alan Woodford (a) (b) Whether the transaction with his aunt is for arm s length consideration There is no definition of arm s length price ; however, it is understood that the term refers to the price obtainable between a willing buyer and a willing seller acting in an open market. It is indicated in the supplied facts that Alan s aunt is in financial difficulty. This may indicate a willingness by her to part with her share of the property for a price negotiated at less than that which would otherwise be obtainable between two parties neither of whom is in financial distress. Therefore, it is possible that the price achieved by Alan for his aunt s share of the property does represent an arm s length price based on the circumstances in which that price was agreed. However, as his aunt is a connected person to Alan for income tax purposes, unless further facts indicate that the price paid by Alan is, in fact, an arm s length price, it is prudent to determine the effects of this transaction as if it is not considered to be at an arm s length price. Where an asset is disposed of to a connected person for a consideration which does not reflect an arm s length price, then for capital gains tax purposes, the asset is deemed to be disposed of for the asset s market value (irrespective of the actual consideration received). In this case, this would be 1,100,000 (being 50% of 2,200,000). For donations tax purposes, the difference between the market value and the price paid by Alan will be deemed to be a donation by his aunt. This would result in a deemed donation of 220,000 (being 20% of 1,100,000). Income tax consequences of the transaction with Alan s mother Where an asset is held jointly by two natural persons, each share of the property must be treated as a separate asset rather than as part disposals of the same asset. His mother is a connected person to Alan, therefore, for capital gains purposes, her share of the property is deemed to be disposed of at market value, i.e. 1,100,000. The property is a pre-valuation date asset on which Alan s mother incurred qualifying expenditure both before and after the valuation date; therefore, time apportionment is necessary. The disposal is also a donation on which donations tax is payable. So a portion of the donations tax incurred must be added to the base cost when determining the capital gain or capital loss. Donations tax Share of the market value of the asset donated: 2,200,000 x 50% 1,100,000 Less donations tax exemption applicable to natural persons (100,000) Amount on which donations tax is to be levied 1,000,000 Donations tax at 20% 200,000 19

7 Capital gains tax Proceeds: 2,200,000/2 1,100,000 Valuation date value: 20% x proceeds less post-valuation date expenditure: 20% x (1,100,000 55,000 (100,000/2)) 199,000 Time apportioned base cost: B = 530,000/2 265,000 A = 55,000 55,000 = 1,100,000 (100,000/2) (selling costs) 1,050,000 Therefore: P = x B/(B + A) = 869,531 N = 2 T = 12 Time apportioned base cost: Y = B + ((P B) x N)/(T + N) 351,362 Choose time apportioned base cost (351,362) Post-valuation date expenditure: 100,000/2 + 55,000 (105,000) Capital gain before donations tax 643,638 Portion of donations tax to be added to base cost: M = Market value of the asset 1,100,000 A = Base cost before donations tax 456,362 D = Donations tax payable 200,000 Y = (M A) x D/M (117,025) Capital gain reduced by the increase in base cost 526,613 educed by the annual exclusion (30,000) Aggregate and net capital gain 496,613 Likely tax: 496,613 x 33 3% x 40% 66,149 It is assumed that Alan s mother has no other capital gains or capital losses in the 2013 year of assessment or any capital losses brought forward from previous years. (c) Base cost for Alan on conclusion of the planned transactions Alan will have an asset with a base cost of 2,200,000 assuming the price paid to his aunt was not considered to be an arm s length price. He would also be able to add the legal costs he incurred and the transfer duty paid to this value. 4 (a) SA Co Ltd (SACL) Treatment of an independent branch The Value-Added Tax Act permits the separate registration of enterprises, branches or divisions [in terms of s.50 of that Act]. First, as SACL is already a registered VAT vendor, the separate registration of its branches may be considered. Second, the branch in Kenya would qualify to be separately registered, as the branch is separately identifiable by location, due to its location in Kenya being far removed from all the other activities of the company in South Africa. Third, the branch needs to maintain an independent system of accounting. The phrase independent system of accounting is not defined. In this case, the branch will be recording all transactions on a live system held by the South African head office. However, it would also seem that the branch is forced to maintain separate records should the internet connection fail as it then submits its records in hardcopy. It is therefore submitted that the branch in Kenya will effectively maintain an independent system of accounting and so can be separately registered for VAT. The application for such registration must be made to the Commissioner of SAS, in writing. The turnover requirements for general VAT registration are not considered for the purposes of separate branch registration as the enterprise would have to first be a vendor before such separate registration can take place. This means that the Kenyan branch could be separately registered before the first transaction with that branch takes place. As an independent branch outside South Africa separately registered, the branch is considered, for VAT purposes, to be a separate person. This means that goods sent to the branch are considered to be supplies made by the South African company to a person outside South Africa. As such, goods sent to the branch would be treated as exports on the date they are sent to the branch and VAT will be levied at the zero rate. Similarly, goods returned from the branch would be considered to be imports and would have to clear customs and trigger deemed input VAT. Should the branch not be registered separately for VAT, then the goods sent to the branch and received from the branch have no VAT consequences. Sales by the branch to its customers in Kenya would be treated as exports only at the point of sale (rather than at the earlier time of supply when the branch was separately registered). It would therefore be more practical to register this branch separately. 20

8 (b) Prop (Pty) Ltd (PPL) Sale of a going concern and deregistration For VAT purposes, PPL currently makes both exempt supplies (being the rental of residential accommodation) as well as taxable supplies (being the rental of commercial properties). Standard rate sale of the buildings The sale of the properties as buildings would be considered a standard rate supply, on which VAT must be charged on the full sale price. This applies to the sale of the residential buildings as well as the commercial buildings in the case of a sale by a VAT vendor. However, as no input VAT would have been claimable when the residential buildings were acquired (as they were acquired to make exempt supplies), an adjustment to input VAT would have to be determined in terms of the VAT Act. While the supply of a building chargeable to VAT at the standard rate to another VAT vendor making taxable supplies would pose no problem greater than an immediate cash flow issue (as the acquiring vendor would be able to claim the VAT as an input), the same is not true of a vendor acquiring the building to make exempt supplies (i.e. the rental of residential accommodation), as in such cases an input would be denied to the vendor. It may therefore be worthwhile in both circumstances to consider selling the buildings as a going concern. Sale as a going concern If the sale(s) is/are made as the sale of a going concern, then it will take place as a taxable supply but with VAT charged at 0%. To constitute the sale of a going concern, the following requirements must be met: (1) the sale must represent the sale of an income earning activity; (2) the agreement (in writing) must confirm that the sale is the sale of a going concern and that the zero rate will apply; (3) the sale must be between VAT vendors; (4) the leasing activity must be sold with the buildings; and (5) all assets necessary for the income earning activity must form part of the sale. In this context, it should be noted that an individual building may qualify as a separate going concern (as each building can represent all of the assets required to continue a particular enterprise). It therefore does not matter whether the buildings are sold separately or as a group. Deregistration for VAT On deregistration, VAT output is levied on all taxable supplies for which a VAT input was claimable based on the lower of the consideration paid for the asset or its market value at the date of deregistration. It is therefore important that deregistration takes place after the disposal of PPL s major assets, otherwise the claw back arising on the assets remaining at the time of deregistration could create a large cash flow difficulty for the company. Conversely, prior to deregistration, PPL will derive considerable benefit from the sale as a going concern, at the zero rate, of the commercial buildings on which VAT input has been claimed at the standard rate. 5 (a) Mr Young (i) Which portfolio to choose Assuming Mr Young s ultimate retirement age is 65 years, then he still has 35 years of service before reaching retirement age. It is therefore suggested that his investment channel should be the portfolio which will have the greatest likelihood of high returns, even if this has the greatest risk, as because of the long time horizon to his retirement, Mr Young should be able to absorb market shocks and corrections. It would appear from the three fund portfolios that the Balanced Portfolio represents the portfolio with the greatest chance of high returns (with the matching higher risk). The fact that Mr Young is only likely to spend five years with his current employer should not change his investment strategy. Ideally, any accumulated funds generated in this fund should be transferred to his next employer s fund or transferred to a preservation fund. This may be done without immediate tax consequence. (ii) Advantages and disadvantages of salary sacrifice over direct payment of contributions Contributions to a provident fund do not currently qualify for a tax deduction. Therefore if an employee makes contributions directly into a provident fund, the contributions must be made from after-tax monies. However, where the employer makes contributions into a provident fund on the employee s behalf in return for a reduced salary (a salary sacrifice ), the contributions are tax deductible for the company (subject to certain limits) and the employee s overall immediate tax burden is reduced because of the lower salary received. In addition, the employer may benefit from an overall reduction in their employee costs if the salary after the sacrifice plus the contributions made is less than the salary before the sacrifice. The two options have differing effects when the employee ultimately receives money from the provident fund, either on withdrawal or retirement. Contributions not permitted as a deduction when they were made may be set off against any lump sum amount taken from the fund and tax is only levied on the excess. But contributions made by the employer are not deductible, so the full amount received will be subject to tax. However, the contributions made by the employee are not increased by any inflationary index resulting in erosion of such a benefit. 21

9 (iii) Taxation of returns within the fund The returns earned on monies held by a provident fund carry no income tax consequences for the employee. The money is not considered to accrue to the employee until the employee accesses the money on withdrawal or retirement. The fund itself is also, currently, free of any income tax on such returns as the funds are taxed only in the employee s hand on exiting the fund by withdrawal or retirement. Tutorial note: This policy with respect to the tax treatment of retirement funds is in line with Government Policy to encourage preservation of benefits until retirement. (iv) Options on changing jobs As pension and provident funds are employer sponsored funds (unlike retirement annuity funds), persons ceasing employment with a particular employer must either withdraw the funds (assuming early retirement is not available) or transfer such funds to a preservation fund or to the new employer s fund. Transfers from one fund to another are generally free of taxation (as the benefit is preserved and not accessed). However, if the employee decides to withdraw the funds (in part or in full) the portion accessed is subject to tax. Only the first 22,500 is tax free (and this limit is applied across all withdrawals over the lifetime of the taxpayer). Above 22,500, withdrawals are subject to tax at progressive rates, up to 36% in the case of withdrawals in excess of 900,000. (b) Mr Old (i) Income tax consequences of each option (1) Convert the accumulated benefits to a life annuity If an annuity is acquired from an insurer, no immediate tax effect will result from accessing the fund benefit. The income tax consequence arises from the on-going taxation of the annuity in each of the subsequent years of assessment. The amount of the annuity will be included in gross income and subject to the progressive tax rates applicable to normal tax. If the pension is the only income received and it is lower than the previous salary, it may be an option to consider. However, as Mr Old will continue to work, taking a pension annuity will only serve to increase his taxable income and thus the tax payable, thereby eroding the benefit of the pension annuity. (2) Take the entire benefit in cash In the case of a provident fund, the full accumulated benefit may be taken as a lump sum in cash. On retirement, the first 315,000 of the lump sum taken is free of tax and larger sums are taxed at progressive rates of up to 36% in the case of sums in excess of 945,000. Even so, this top rate remains less than the maximum marginal rate applicable to normal tax. However, the monetary limits of the tax bands do not apply per fund but per taxpayer and over the life of the taxpayer. This means that where an individual receives cash benefits from more than one fund, the lump sums will count cumulatively. Mr Old should be aware of this fact if any of his future contract work will give rise to provident fund contributions and thus benefits. (3) Part cash and part annuity The tax consequences of this option will be a combination of the effects outlined for options (1) and (2) above. (ii) Other considerations The need to seek financial advice from a registered financial adviser in terms of the Financial Intermediaries Control Act (FICA) regarding any sums to be invested in a collective investment scheme. The potential benefit of deferring taking any life annuity, given that age is a factor in determining the level of annuity which can be purchased with a given lump sum (i.e. the older the individual is on purchase, the greater the annuity rate). The level of his income from the contract work compared to his existing salary and the extent to which he may need to generate additional income (via an annuity or from investments) to maintain his standard of living. The extent to which he has an immediate need for a cash lump sum, e.g. to pay off debts. The degree of risk he is prepared to take given his age/investment time horizon and thus the type of collective investment he should purchase. Note: The above list is not exhaustive and marks would also be given for other valid points. 22

10 Professional Level Options Module, Paper P6 (ZAF) Advanced Taxation (South Africa) 1 Op Co (Pty Ltd/Hold Co (Pty) Ltd/Mr Shane Dealer December 2013 Marking Scheme Marks (i) Op Co (Pty) Ltd Identification of the order required to get the values for Mr Dealer Discussion of the deductibility of the severance packages and liquidation costs 2 Calculation of income tax liability 6 Calculation of VAT liability 3 Determination of liquidation distribution amount (i.e. the total equity) 5 Determination of the dividend amount 1 Identifying the applicability of the exemption from dividends tax 1 Hold Co (Pty) Ltd easons why there is no income tax liability 3 eason why VAT need not be considered Determination of liquidation distribution amount (i.e. the total equity) 1 Determination of the dividend amount Calculation of the dividends tax 1 Calculation of the amount received by Mr Dealer 26 Maximum 24 (ii) Explanation as to why a limitation applies 1 Application of the rule regarding production of exempt income and related disallowance of the deduction 2 Basis of apportionment 1 Calculation of the permitted deduction 5 Maximum 4 (iii) Identification of amount accruing as gross income 1 Application of the dividend exemption 1 Calculation of additional/total taxable income Confirmation that no capital gains tax will arise 1 3 Maximum 3 Professional marks Format and presentation of the letter 1 Appropriate use of an appendix 1 Effectiveness of communication 2 4 Total 35 23

11 2 James Ncayiyana Marks (a) Creation of trust should be via a cash loan 1 No donations tax as no gift No capital gains consequences if loan is in local currency 1 Discussion of low interest issues 1 4 Maximum 3 (b) (i) Anti-avoidance rules apply in the case of inter vivos trusts 1 Identification of the specific anti-avoidance rules for income tax 3 eference to similar rules applying for capital gains 1 Application of the rules to the JN Trust 4 Discussion of the investment plan of the JN Trust resulting in a revenue (gross income) effect 1 Explanation regarding the deemed capital intent after three years 1 ecommendation of action to be taken by the trustees Position regarding the deduction of the investment manager s fees 1 13 Maximum 11 (ii) Loan will be an asset of James s estate 1 Identification of the effect of the will (legacy to spouse) on net estate value 1 Conclusion that no duty will arise due to abatement 1 3 (c) Vested right to income is an asset for capital gains purposes 1 Change from vested to discretionary constitutes a disposal 1 Capital gain (loss) applicable to relevant beneficiaries eference to the effect of anti-avoidance rules in the case of minor children 3 (d) (i) Control principle means that there are no estate duty consequences except in the case of a sole or controlling trustee 2 (ii) Portion of assets equal to vested right to capital forms part of estate 1 Not tax efficient because in addition to the loan 1 Potential increase in value of the estate from unspent income vested 1 3 Total 25 24

12 3 Alan Woodford Marks (a) Meaning of arm s length price 1 Discussion of why 20% discount could still be an arm s length price 2 But prudent to assume otherwise in the absence of other evidence as aunt is a connected person 1 Capital gains tax consequences 1 Donations tax consequences 1 6 Maximum 5 (b) Explanations: Disposal is of a separate half share (not a part disposal) Disposal is at market value as mother is a connected person Pre-valuation date asset so time apportionment applies Donations tax payable is added to base cost Calculation of donations tax 1 Calculation of capital gains tax: Proceeds Valuation date values: 20% of proceeds (after subtracting post-valuation date expenditure) 1 Time apportioned base cost 3 Choice and post-valuation date expenditure 1 Donations tax to be added to base cost 2 Annual exclusion Income tax effect 1 Assumption re no other capital gains/losses 13 (c) Market value identified as initial base cost 1 Addition of transfer duty and legal fees noted 1 2 Total 20 25

13 Marks 4 (a) SA Co Ltd Separate registration permitted by VAT Act 1 equires legal entity (SACL) to be a vendor 1 equires branch to be in a separate identifiable location 1 equires branch to have an independent system of accounting 1 Discussion of whether Kenya branch has an independent system of accounting 1 Application must be in writing Turnover requirement not applicable, with reason 1 VAT Act sees the independent registered branch as a separate person Effect on goods sent to the separately registered branch 1 Effect for goods returned to the head office 1 Effect on goods if branch not separately registered 1 11 Maximum 10 (b) Prop (Pty) Ltd Identification of exempt and taxable supplies currently made 1 Sale of a building is standard rated 1 Applies to residential accommodation as well as commercial buildings 1 esidential buildings sold at the standard rate require an input adjustment 1 Impact for acquirer of commercial buildings sold at the standard rate Impact for acquirer of residential buildings sold at the standard rate 1 Going concern sale will be zero rated 1 equirements for a going concern sale 2 Going concern sale may be of an individual building Basis for output VAT charge on deregistration 1 Explanation of why it is important to carry out sales before deregistration 1 11 Maximum 10 Total 20 26

14 Marks 5 (a) Mr Young (i) Length of time horizon until retirement 1 Can afford to choose the highest return, even if highest risk 1 Identify relevant portfolio 1 Short time with this employer should not affect the use of a long-term strategy with retirement funding 1 4 Maximum 3 (ii) No deduction for direct contributions to a provident fund by employee 1 Explanation of salary sacrifice and its effects for both the employer and employee 2 Position on retirement or withdrawal from the fund 2 5 (iii) No tax consequences on returns earned on monies in the fund 1 (iv) Options identified as transfer or withdrawal 1 No tax effect on transfer Tax effect on withdrawal 1 3 (b) Mr Old (i) No immediate tax effect on purchase of annuity 1 Annuity subject to normal tax on an ongoing basis 1 Cumulative with other taxable income, e.g. from contract work Discussion of taxation of lump sum benefits 1 Identification of maximum rate as being less than for normal tax eference to monetary limits being per taxpayer (not per fund) 1 Option (3) just a combination of options (1) and (2) 5 Maximum 5 (ii) Financial advice should be obtained from a registered financial adviser 1 Any other TWO considerations (1 mark each) 2 3 Total 20 27