TAX4862 NTA4862 - Unisa · Income Tax 2019) (underlining and making summaries) and familiarising...

TAX4862/105/0/2019 NTA4862/105/0/2019

Tutorial letter 105/0/2019

APPLIED TAXATION (CTA Level 2)

TAX4862

NTA4862

Year module

Department of Financial Intelligence

IMPORTANT INFORMATION:

This tutorial letter contains learning units 8 to 10 as well as self-assessment assignment 03

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CONTENTS

ORIENTATION .................................................................................................................................... 4

I INTRODUCTION ...................................................................................................................... 4

II STUDY PROGRAMME AND TIME FRAME ............................................................................. 4

III ABBREVIATIONS .................................................................................................................... 5

IV BEANCOUNTER SCENARIO .................................................................................................. 5

V LECTURERS ........................................................................................................................... 5

VI IMPORTANT DATE FOR THIS TUTORIAL LETTER .............................................................. 5

8 SPECIAL DEDUCTIONS AND ASSESSED LOSSES ............................................................. 6

8.1 TIME ALLOCATION FOR THIS LEARNING UNIT .................................................................. 6

8.2 BACKGROUND LU 8 .............................................................................................................. 6

8.3 OUTCOMES OF THIS LEARNING UNIT ................................................................................. 7

8.4 BEANCOUNTER SCENARIO .................................................................................................. 7

8.5 LEARNING UNIT CONTENT ................................................................................................... 9

8.5.1 Study approach ....................................................................................................................... 9

8.5.2 Table of Reference ................................................................................................................ 10

8.5.3 Paragraphs in SILKE which you may ignore .......................................................................... 13

8.6 LAW AMENDMENTS ............................................................................................................. 13

8.7 NOTES ON THE GENERAL DEDUCTION FORMULA, SPECIAL DEDUCTIONS AND ASSESSED LOSSES ............................................................................................................ 14

8.7.1 The general deduction formula (section 11(a) and section 23(g) and SILKE 6.3 and 6.5.7) ... 14

8.7.2 Pre-trade expenditure and losses (section 11A and SILKE 6.2.1) .......................................... 16

8.7.3 Prepaid expenditure (section 23H and SILKE 6.4) ................................................................. 18

8.7.4 Tax treatment of leases versus suspensive sale agreements ................................................ 19

8.8 OUTCOMES OF THE BEANCOUNTER SCENARIO ............................................................. 20

9 CAPITAL ALLOWANCES AND RECOUPMENTS ................................................................ 22

9.1 TIME ALLOCATION FOR THIS LEARNING UNIT ................................................................ 22

9.2 BACKGROUND LU 9 ............................................................................................................ 22

9.3 OUTCOMES OF THIS LEARNING UNIT ............................................................................... 23

9.4 BEANCOUNTER SCENARIO ................................................................................................ 23

9.5 LEARNING UNIT CONTENT ................................................................................................. 23

9.5.1 Study approach ..................................................................................................................... 23


9.5.3 Parts of paragraphs in SILKE which you may ignore ............................................................. 28

9.6 LAW AMENDMENTS ............................................................................................................. 28

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9.7 NOTES ON CAPITAL ALLOWANCES AND RECOUPMENTS ............................................. 29

9.7.1 The acquisition of assets ....................................................................................................... 29

9.7.2 Lease of assets (rented/hired/leased) .................................................................................... 31

9.7.3 Movable assets ..................................................................................................................... 32

9.7.4 Sections 11(e) and 12C allowances summary (SILKE 13.3.1 & 13.3.3) ................................. 32

9.7.5 Section 12E – deduction in respect of the assets of a small business corporation (SILKE par 13.3.4) ................................................................................................................................... 35

9.7.6 Immovable assets.................................................................................................................. 36

9.7.7 Summary of section 23D (SILKE 13.7.6) ............................................................................... 36

9.7.8 Intellectual property (sections 11(gB) and 11(gC) and SILKE 13.8.1 ..................................... 37

9.7.9 Recoupment: acquisition of hired assets (section 8(5) and SILKE 13.10.6) ........................... 38

9.7.10 Unquantified amounts (section 24M, par 39A of the 8th Schedule and SILKE 6.3.2.1, 13.10.1 and 17.9.4) ............................................................................................................................ 39

9.8 OUTCOMES OF THE BEANCOUNTER SCENARIO ............................................................. 43

10 TRADING STOCK .................................................................................................................. 44

10.1 TIME ALLOCATION FOR THIS LEARNING UNIT ................................................................ 44

10.2 BACKGROUND LU 10........................................................................................................... 44

10.3 OUTCOMES OF THIS LEARNING UNIT ............................................................................... 45

10.4 BEANCOUNTER SCENARIO ................................................................................................ 45

10.5 LEARNING UNIT CONTENT ................................................................................................. 45

10.5.1 Study approach ..................................................................................................................... 45


10.5.3 Parts of paragraphs in SILKE which you may ignore ............................................................. 47

10.6 LAW AMENDMENTS ............................................................................................................. 47

10.7 NOTES ON TRADING STOCK .............................................................................................. 47

10.7.1 Change of intention ............................................................................................................... 47

10.7.2 Trading stock applied for purposes other than trade (section 22(8) and SILKE par 14.7)....... 49

10.7.3 Anti-avoidance provisions (s 23F) .......................................................................................... 50

10.7.4 Deemed capital receipts from the disposal of shares (s 9C) .................................................. 50

10.7.5 Share dealers ........................................................................................................................ 51

10.8 OUTCOMES FOR THE BEANCOUNTER SCENARIO .......................................................... 52

SECTION B: INTEGRATED EXAMPLE ............................................................................................ 53

SECTION C: SELF-ASSESSMENT ASSIGNMENT .......................................................................... 65

SECTION D: PRIOR YEAR TEST ................................................................................................... 136

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ORIENTATION

I INTRODUCTION This tutorial letter is divided into three learning units:

Learning unit 8 deals with the general deduction formula, prohibitions, special deductions and assessed losses.

Learning unit 9 deals with capital allowances and recoupments.

Learning unit 10 deals with trading stock and share transactions (section 9C).

The goal of this tutorial letter is to assist you in making the most of the time available to master the topics in this tutorial letter. Follow the guidelines and keep to the time limits (remember that these limits are based on the fact that certain topics have already been covered in your undergraduate studies).

II STUDY PROGRAMME AND TIME FRAME The learning units in this tutorial letter should be covered during the week of 27 March – 2 April 2019 as set out in the 2019 study programme in TL101 and CASALL2/301. If you are studying part time we suggest that you study 3 hours per day during weekdays (15 hours) and 15 hours over a week-end, that is a total of 30 hours per study week. Full time students should adapt their study programme to full days.

Your time should be divided into two parts:

- Obtaining the required knowledge (19 hours)

This would entail working through this tutorial letter, the textbook (SILKE: South African Income Tax 2019) (underlining and making summaries) and familiarising yourself with the Income Tax Act – covered in section A of this tutorial letter.

- Application of knowledge and revision of difficult concepts (11 hours) This would entail the completion of the integrated example, the self-assessment assignment

and the prior year’s test (test 2 of 2018) – contained in sections B, C and D of this tutorial letter. Work through as many questions as possible in your own time, so that you can assess your knowledge and revisit any areas that you have difficulty understanding.

Day Month Hours LU Topic

Wednesday 1 27 Mar 3

8

General deduction formula, pre-trade expenditure and losses, prohibited deductions, prepaid expenditure, prohibition against double deductions, special deductions and assessed losses

Thursday 2 28 Mar 3

Friday 3 29 Mar 3 9 Capital allowances and recoupments

Weekend 4 & 5

30 Mar & 31 Mar

8

2 10 Trading stock and share transactions

2 Section B of this tutorial letter

3 Section C of this tutorial letter

Monday 6 1 Apr 3 Section C of this tutorial letter

Tuesday 7 2 Apr 3 Section C of this tutorial letter

Pre-test revision

Section D

Total hours 30

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III ABBREVIATIONS The list of abbreviations used in the tutorial letters is contained in TL 102/2019. Please take note of the following additional abbreviations relevant to this tutorial letter:

Abbreviation Meaning of abbreviation

S Section

CGT Capital gains tax

REIT Real estate investment trust

ITC Initial Test of Competence

IV BEANCOUNTER SCENARIO We will be continuing our investigation of the Beancounter family’s tax problems and financial affairs. To follow this you will need to refer back to TL102 as well as TL103 and TL104.

V LECTURERS The following lecturers compiled this tutorial letter:

Ms L Brits Ms A Heyns Ms M Ndlovu Ms N Thoothe Please contact any of the tax lecturers should you have questions about this tutorial letter.

You can also send your queries (regarding administrative and academic matters) and comments via e-mail to [email protected] (note that e-mail correspondence is the preferred method of communication – refer to TL101/2019 in this regard). For queries regarding administrative matters, phone the administrative officer on +27 12 429 2947. For queries regarding academic matters, you can contact any of the lecturers or you can contact the administrative officer on +27 12 429 2947, who will put you in touch with the relevant lecturer on duty or he/she will take a message and the lecturer will then contact you as soon as possible. VI IMPORTANT DATE FOR THIS TUTORIAL LETTER

Date of Test 2: TUESDAY, 23 April 2019

Mainly the topics covered in this tutorial letter, together with the relevant case law, will be assessed in test 2. Remember that all topics covered in previous TLs until now (for example VAT), can be incorporated in your assessment.

mailto:[email protected]

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8 SPECIAL DEDUCTIONS AND ASSESSED LOSSES

WORK PLAN FOR 27 and 28 MARCH 2019 (DAY 1 & 2)

8.1 TIME ALLOCATION FOR THIS LEARNING UNIT

A total of 6 hours (3 hours + 3 hours) of your study time this week have been allocated to LU 8. The following time allocation is recommended:

Topic hours

General deduction formula, pre-trade expenditure and losses, prohibited deductions, prepaid expenditure and prohibition against double deductions

3

Special deductions – employee-related expenses

Special deductions – other

Special deductions – section 24 debtors’ allowance

3

Special deductions - section 24C allowance in respect of future expenditure on contracts

Assessed losses

Comprehensive example 12.24 in SILKE par 12.13

Total 6

The above time allocation is an indication only. The amount of time you need to spend on each topic will be greatly influenced by the knowledge you already have from undergraduate and previous postgraduate studies. You should therefore adapt the time allocation wherever necessary to suit your levels of prior knowledge.

8.2 BACKGROUND LU 8 In this learning unit you will study the general deduction formula, the prohibited deductions, as well as those deductions which are not permitted in terms of the general deduction formula, but contained in specific sections of the Income Tax Act (referred to as “special deductions”) and you will also learn about assessed losses.

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The topics covered in this learning unit fit into the tax framework as follows: TAX FRAMEWORK

GROSS INCOME (section 1) LESS: Exempt income (sections 10 and 10A to 10C) = INCOME LESS: Deductions and allowances (sections 11 – 24P, excluding s 20 and s 18A) LESS: Assessed loss brought forward (section 20) ADD: Amounts to be included in taxable income including TAXABLE CAPITAL GAINS LESS: Deductions in terms of s 11 LESS: Qualifying donations (section 18A) = TAXABLE INCOME Use taxable income to calculate NORMAL TAX PAYABLE.

8.3 OUTCOMES OF THIS LEARNING UNIT

After studying this learning unit, you should be able to meet all the outcomes listed at the beginning of the applicable chapters of SILKE, but excluding those topics which are not included in the table of reference as provided in this tutorial letter.

The most important outcome, however, is that you should be able to answer case study and integrated questions similar to those provided in sections B, C & D of this tutorial letter.

8.4 BEANCOUNTER SCENARIO Bizzie Beancounter has decided to start her own business venture, which will be carried out in her own name. She has located the perfect business premises, available for letting, where she intends to start a dry-cleaning business (recognised by the Commissioner as a process similar to a process of manufacture). Bizzie has decided to call her new business "Bizzie-as-a-bee Cleaners”.

Bizzie has intended to open the doors of her new business on 1 March 2018 (with the financial year ending on 28/29 February each year). Due to an unforeseen delay in obtaining an overdraft facility from her bank, trading only commenced on 15 May 2018. Bizzie has registered as a vendor for VAT purposes in her own name, as the estimated total value of taxable supplies will exceed R1 000 000 in the first twelve months based on fixed contractual agreements.

Bizzie paid the rent of the business premises on 1 June 2018 for 12 months in advance. She has also appointed four permanent staff members (not connected to herself) to assist her in dealing with the customers and to operate the dry-cleaning machine. Bizzie pays the staff members a cash salary every month as well as 50% of their monthly medical aid membership, as per the medical aid fund contract. Bizzie expects her business to suffer a loss by the end of the financial year. Bizzie still takes care of the day-to-day management of the business.

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Bizzie wants to know the following: whether the expenses she has incurred prior to 15 May 2018, will be deductible for income tax

purposes;

will she be able to deduct the rent paid for the business premises for tax purposes;

are the monthly cash salaries and medical aid fund contributions paid by her deductible for tax purposes;

she knows that normal tax is payable annually in respect of a year of assessment; therefore she wants to know what will happen if the business suffers a loss in the current financial year of assessment. Should she therefore rather not pay the rent in advance so that she will be able to deduct the rent in the following year?

Before attempting to help Bizzie with her questions, you should work through and master LU 8.

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8.5 LEARNING UNIT CONTENT

8.5.1 Study approach In this learning unit, we provide you with a Table of Reference which contains the references to all the sections which must be studied in this learning unit together with a reference to the relevant paragraph in SILKE and a reference to additional notes provided (if any) in the tutorial letter, as well as an indication of whether a specific section is examinable or not. The Table of Reference is presented in such a way that you should use it to guide you through the content of the learning unit in this tutorial letter. We also guide you on how to spend your time. You should therefore work your way through the content by starting at the top of the table and working your way through to the end. The ideal way to study tax is to first read the specific section in the Income Tax Act and then to study the relevant paragraph(s) in SILKE together with any additional notes on that section included in this tutorial letter. Also work through the examples in SILKE, because the examples illustrate the application of the theory of a section. In addition, please refer to TL102 for the relevant case law that applies to this learning unit. As the allocated time is limited, you will require additional reading time to study case law. You only have to study the case law in TL102. Case law mentioned in SILKE which is NOT dealt with in TL102 (highlighted in grey in the textbook) may be ignored.

A note on how to study and refer to case law: Mark(s) will be awarded in a test or the exam for stating the correct principle(s) of important case law. Refer to TL102 which contains short summaries of the prescribed case law. Note that these summaries do not represent an exhaustive list of established principles and merely provides an indication of the relevant part(s) of the tax legislation considered and principles considered/established in the respective cases. Please study these summaries together with the summaries of the respective cases in SILKE. It is important that you are able to apply the relevant principle(s) of particular cases to a particular set of facts.

We are aware of the fact that most of our students study part time. We therefore realise that you may not always have the time available to follow the above study approach fully, with specific reference to our recommendation that you first read a section in the Income Tax Act. However, you still need to flag and underline your Income Tax Act in order for you to benefit from the limited open book policy in the tests, the examination and the 2020 ITC examinations. SILKE has a “Table of provisions” towards the back of the book (just before the Subject index). This is a handy table to use if you have a specific section on which you need more information. The table provides the paragraphs in SILKE which contain information on that specific section.

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8.5.2 Table of Reference As mentioned above, the following table contains references to all the sections of the Income Tax Act that must be studied in this learning unit together with a reference to the relevant paragraph in SILKE and a reference to additional notes provided in the tutorial letter (if any), as well as an indication of whether a specific section is examinable or not. Download the relevant Interpretation notes from the following link: http://www.sars.gov.za/Legal/Interpretation-Rulings/Interpretation-Notes/Pages/default.aspx

(Relevant extracts of interpretation notes will be included in your assessments.)

Reference to the Income

Tax Act Topic

Reference to SILKE

Reference to notes in

TL Examinable

DAY 1 (3 hours)

General deduction formula, pre-trade expenditure and losses, prohibited deductions, prepaid expenditure and prohibition against double deductions (1 hour)

s 11(a) & 11(x) s 23

Overview and general deduction formula Prohibited deductions Excluding: 23(n), (o)(iii) & (p)

12.1 & 6.3

6.5

8.7.1 Yes

Yes

s 11A Pre-trade expenditure and losses 6.2.1 8.7.2 Yes

Interpretation Note No. 51 (Issue 5): Pre-trade expenditure and losses describes s 11A in more detail.

s 23H Prepaid expenditure 6.4 8.7.3 Yes

s 23B Prohibition against double deductions 6.6 Yes

s 23(g) Excessive expenditure 6.8 Yes

s 23C Cost of assets and VAT Excluding: 23C(2)

6.9 Yes

Specific transactions 6.10 Yes

Special deductions - employee-related expenses (1 hour)

s 11(cA)

Restraint of trade payments

12.2.1 Yes

Interpretation Note No. 7: Restraint of trade payments (Bear in mind that para-graph (cA) of the gross income definition, as well as section 11(cA) referred to in the interpretation note were amended in 2008 (i.e. the terms “personal service company” and “personal service trust” were replaced by the term “personal service provider”). It is thus the previous terms that are still reflected in Interpretation Note No 7.

s 11(l) Fund contributions by employers 12.2.2 Yes

s 12M Deduction of medical lump sum payments 12.2.3 No

s 11(lA) Shares issued by employers in terms of s 8B 12.2.4 No

s 11(m) Annuities to former employees or partners and their dependants

12.2.5 Yes

s 11(w) Life insurance premiums 12.2.6 No

http://www.sars.gov.za/Legal/Interpretation-Rulings/Interpretation-Notes/Pages/default.aspx

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Tax Act Topic

Reference to SILKE


TL Examinable

s 7B Variable remuneration (This sections deals with both incurral and accrual. The accrual aspect will be covered in TL107)

12.2.7 Yes

s 12H

Learnership agreements (The question will state that it is a “registered learnership agreement”, date of registration and NQF level will be given)

12.2.8 Yes

Interpretation Note No. 20 (Issue 7): Additional deduction for learnership agreements.

Special deductions – other (1 hour)

s 11(c) Legal expenses 12.3

Yes

s 11(d)

Repairs 12.4 - 12.4.2

TL102 Yes

Interpretation Note No. 74 (Issue 2): Deduction and recoupment of expenditure on repairs (Although the most important parts of this interpretation note are also covered in SILKE 12.4, it is important that you also read through this interpretation note, since the distinction between repairs and improvements is difficult. This distinction is often the focus of a test or exam question, either as a discussion or as part of a calculation question.

Case law - Flemming v Kommissaris van Binnelandse

Inkomste

- CIR v African Products Manufacturing Co Ltd

Yes

s 11(i) Bad debt 12.5 Yes

s 11(j) Doubtful debt (Question will state if IFRS 9 is applied or not and provide either the IFRS 9 loss allowance or days that debt is in arrears)

12.6

Yes

s 11(nA) & (nB)

Repayment of employee benefits 12.7 TL107 Yes

s 12J Deductions in respect of the issue of Venture Capital Company shares

12.8 No

s 18A(1), (3), (3A) and (3B)

Donations to public benefit organisations and other qualifying beneficiaries Excluding: - any reference to collective investment schemes - 18A(1A), (1B), (1C), (2), (2A), - (2D), (4) – (7)

(It will be stated that a section 18A receipt was obtained)

12.9 Yes

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DAY 2 (3 hours)

Special deductions – section 24

s 24 Allowance for outstanding debt: Credit agreements and debtors’ allowance (Only the gross profit method will be tested)

12.10 8.7.4 Yes

Interpretation Note No. 48 (Issue 3): Instalment credit agreements and debtors’ allowance.

Special deductions – section 24C

s 24C Future expenditure on contracts (The methods which must be used to make this determination will be provided in a question)

12.11 Yes

Interpretation Note No. 78: Allowance for future expenditure on contracts.

Assessed losses

s 20

Assessed losses 12.12 – 12.12.3

Yes

s 20A Ring-fencing of assessed losses of natural persons

12.12.1 & 7.1.1

TL107

Interpretation Note No. 33 (Issue 5): Assessed losses: Companies: The “trade” and “income from trade” requirements.

Case law: - SA Bazaars (Pty) Ltd v CIR

- Robin Consolidated Industries v CIR

TL102 Yes

Comprehensive examples

Do the comprehensive example 12.24 in SILKE par 12.13.

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8.5.3 Paragraphs in SILKE which you may ignore The following paragraphs in SILKE may be ignored as these paragraphs are excluded from the syllabus:

Silke reference Topic

6.7 Limitation of deductions in respect of certain short-term insurance policies (s 23L)

6.5.13 Government grants (s 23(n))

6.5.15 The cession of policies by an employer (s 23(p))

12.2.3 Deduction of medical lump sum payments (s 12M)

12.2.4 Shares issued by employers in terms of s 8B (s 11(lA))

12.2.6 Life insurance premiums (s 11(w))

12.8 Deductions in respect of the issue of Venture Capital Company shares (s 12J)

8.6 LAW AMENDMENTS

The following law amendments were promulgated in the Taxation Laws Amendment Act No. 23 of 2018 (on 17 January 2019).

Section 11(j)

Doubtful debt allowance

Prior to the amendments, section 11(j) provided a discretion to the Commissioner to allow a doubtful debt allowance of up to 25% of the face value of doubtful debt.

With effect from years of assessment commencing on or after 1 January 2019 section 11(j) has been amended in support of the move towards a self-assessment income tax system and now provides for two different allowance options, namely:

1) Taxpayers that apply IFRS 9 to the debt (s 11(j)(i)):

The doubtful debt allowance is the sum of –

- 40% of the sum of the loss allowance relating to impairment measured at an amount equal to the lifetime expected credit loss in respect of debt other than in respect of lease receivables, plus

- Bad debt written off and reported in the financial statements that was not allowed as a section 11(i) bad debt deduction and that was included in the taxpayer’s income in the current or any previous year, plus

- 25% of the loss allowance relating to impairment in respect of debt other than in respect of lease receivables or that is already included in the 40% above.

2) Taxpayers that do not apply IFRS 9 to the debt (s 11(j)(ii)):

The doubtful debt allowance is the sum of –

- 40% of debt in arrears for 120 days or more, plus

- 25% of debt in arrears for 60 days or more (excluding debt to which IFRS 9 applies or that is already included in the 40%).

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Section 11(j)

Doubtful debt allowance (continued)

The current year allowance must be added back in the next year of assessment (proviso to s 11(j)).

A question will state if IFRS 9 is applied or not and provide either the IFRS 9 loss allowance or the days that the debt is in arrears. Also remember that the allowance can only be claimed if the debt is due to the taxpayer and it would have been allowed as a deduction under another provision of the Income Tax Act (meaning it must have previously been included in the taxpayer’s income).

Note that section 11(j) in its previous form (that applies in respect of years of assessment commencing before 1 January 2019) is excluded from the syllabus.

Section 18A Deduction of donations to certain organisations

Section 18A has been amended to extend the scope of tax deductible donations in respect of international donor funding organisations. The words “programme, fund, High Commissioner, office, entity or organisation have been added.

Further, as a result of the transformation of the Financial Services Board into the Financial Sector Conduct Authority, “Financial Services Board” has been replaced by “Financial Sector Regulation Act”.

Section 20A Ring-fencing of assessed losses of certain trades

The amendment clarifies that assessed losses relating to cryptocurrencies are ring-fenced by adding “the acquisition or disposal of any cryptocurrency” to the list of suspect trades in section 20A(2)(b) (s 20A(2)(b)(ix)).

8.7 NOTES ON THE GENERAL DEDUCTION FORMULA, SPECIAL DEDUCTIONS AND ASSESSED LOSSES

8.7.1 The general deduction formula (section 11(a) and section 23(g) and SILKE 6.3 and 6.5.7)

The general deduction formula is contained in section 11(a) read with section 23(g). Section 11(a) contains the positive criteria and section 23(g) the negative criteria. Section 11(a) provides for a deduction of:

expenditure and losses

actually incurred (means paid or there must be an unconditional liability to pay)

during the year of assessment (the courts established that it is a silent requirement (meaning that section 11(a) does not specifically require it))

in the production of income (means that the act that gave rise to the expenditure is closely connected to the income-earning activities),

provided such expenditure and losses are not of a capital nature (means that the expenditure/ loss is more closely related to the income-earning operations than to the income-earning structure, it does not form part of fixed capital but rather floating capital (trading stock), or it did not create an enduring benefit).

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The diagram below shows the treatment of expenditure and losses in terms of section 11(a) and 23 once their nature has been determined:

Section 23(o) – Interpretation Note: No 54: Deductions – Corrupt activities, fines and penalties (see SARS website)

Interpretation Note: No. 54 (Issue 2) was issued on 25 January 2017 and examines the meaning and scope of section 23(o). Section 23(o) prohibits the deduction for income tax purposes of expenditure incurred in respect of:

corruption or a corrupt activity; or

a fine or penalty imposed as a result of an unlawful activity.

In other words, corrupt payments such as bribes, fines and penalties for unlawful activities are not tax deductible. However, the deduction of bona fide commercial penalties is not affected by the provisions of section 23(o). The deduction of such commercial penalties must be considered in terms of the general deduction formula.

General deduction formula: Case Law

Be aware of the difference between the tests for establishing whether an item of expenditure is incurred “in the production of income” and whether that expenditure is “capital or revenue in nature”. THE TESTS ARE DIFFERENT. The tests used to establish whether gross income is capital or revenue in nature are also completely different to the tests used to establish whether expenditure is capital or revenue in nature. The table below provides a list of the different tests established by the courts in determining the capital/revenue nature of gross income versus expenditure.

Expenditure and losses

Revenue nature

General deduction formula and section 23

Deduction for normal tax purposes

No CGT effect

Capital nature

Special deductions and

allowances section 23

Deduction or allowance for

normal tax purposes

Reduces base cost of asset

Base cost of capital asset

No deduction for normal tax purposes

Forms part of base cost for

CGT purposes

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Gross income – “capital/revenue” tests Expenditure – “capital/revenue” tests

“tree and fruit” principle

intention (most important test)

(subjective factor) - mere realisation of

capital asset or pursuance of profit-

making scheme

change in intention (“crossing the

Rubicon”)

mixed intentions – main/dominant

intention

alternative intentions - revenue

objective factors

fixed v floating capital

closeness of the connection to the

income-earning operations or income-

earning structure (the ‘operating v

structure’ test)

fixed v floating capital

“once and for all” expenditure

“enduring benefit” test

the nature of the transaction

the nature of the business carried on

8.7.2 Pre-trade expenditure and losses (section 11A and SILKE 6.2.1) SARS issued Interpretation Note: No. 51 (Issue 5) on 27 June 2018, which provides guidance on when pre-trade expenses (including expenditure and losses) will be allowed as a deduction for income tax purposes.

Below is an explanation of the working of section 11A:

Section 11A allows the deduction of pre-trade expenses in the year of assessment in which trade commences, subject to certain requirements (irrespective of when the expenses were incurred).

Section 11A is subject to section 23H.

The section 11A deduction applies to all pre-trade expenses actually incurred which would have been allowed as a deduction in terms of sections 11 (excluding section 11(x)), 11D or 24J had the expenses been incurred after commencement of the carrying on of that trade.

This means that the pre-trade expenses are ring-fenced and only pre-trade expenses actually incurred in the preparation for carrying on the particular trade will be deductible from the income resulting from that specific trade. Also, where pre-trade expenses have been incurred towards a particular project and that project is abandoned prior to the commencement of trade, such pre-trade expenses will not be deductible under section 11A. Read through examples 3 and 4 of Interpretation Note 51.

Certain capital allowances granted in terms of the following paragraphs of section 11 can qualify for deduction under section 11A(1) (provided that all the necessary requirements have been met): - (cA) (restraint of trade payments - LU8); (e) (wear-and-tear allowance see note below); (f)

(lease premiums - LU 9); (g) (leasehold improvements - LU9); (gA) (ignore); (gC) (intellectual property – LU 9); (gD) (ignore) and (hB) (ignore).

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Note: (Work through example 5 of Interpretation Note 51) A wear-and-tear (section 11(e)) allowance will qualify for deduction under section 11A only if the specific asset: - has a cost (therefore, an asset acquired by, for example, a donation or inheritance, will

not qualify); and - was used during the pre-trade period.

A section 11(e) allowance is not available if the asset is not used for purposes of the taxpayer’s trade. Therefore, if the asset would not have qualified for an allowance under section 11(e) (had the asset been acquired after commencement of the carrying on of that trade), it will not qualify for a deduction under section 11A. An example where a section 11A deduction is not available is where the asset was acquired but kept in storage pending the commencement of that trade.

In terms of section 11A(2), the deduction is limited to the taxable income derived from the particular trade prior to the deduction of the section 11A pre-trade expenses. Therefore, pre-trade expenses cannot create (or increase) an assessed loss in respect of the relevant trade. Furthermore, the excess is ring-fenced. In other words, it may not be set-off against income from a different trade. The excess can, however, be carried forward to the subsequent year of assessment for set-off against taxable income derived from the same trade. Should the taxpayer have an assessed loss as opposed to taxable income, the assessed loss and the excess pre-trade expenses will be carried forward to the subsequent year of assessment at the same time. The excess pre-trade expenses will be carried forward each year until it can be set off against any taxable income derived from that trade.

Work through examples 6 and 7 of Interpretation Note 51.

Section 11A also applies to a small business corporation.

The following diagram may assist in better understanding of the application of section 11A: Year of assessment

Deductible in next year of assess-ment once trade has commenced (deduction limited to taxable income from relevant trade) (section 11A)

Deductible in current year, once trade has commenced (deduction limited to taxable income from relevant trade) (section 11A)

Deductible mainly under sections 11-18A and 23 in current year (deductions NOT limited to taxable income from the relevant trade, therefore an assessed loss may be created.

Start-up costs Normal costs

Commence trading

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8.7.3 Prepaid expenditure (section 23H and SILKE 6.4) Section 23H seeks to match the timing of the deduction in terms of sections 11(a), (c), (d), (w), or 11A with the amount of goods supplied, the period of service or the entitlement to other benefits derived during that year of assessment. In other words, section 23H limits the deduction allowable in terms of sections 11(a), (c), (d), (w), or 11(A) even though the amount has actually been incurred.

There are four instances when section 23H will not apply and we comment on two of them as follows:

The first is where all the goods or services are supplied or all the benefits are enjoyed within six months after year-end. No apportionment should then be made in terms of section 23H, thus section 23H will not apply.

The second instance, namely “if the aggregate of all the amounts of expenditure, which may otherwise have been limited by section 23H, does not exceed R100 000”, should be applied last (thus, excluding cases where the benefit will be received within six months).

Example: Prepaid expenditure (section 23H)

Year of assessment ended 28 February 2019 Full

expense R

Prepaid portion

R Rent paid (section 11(a)) (prepaid for 4 months after Feb 2019)

330 000

x 4/12 months =

110 000

Insurance (section 11(a)) (prepaid for 8 months after Feb 2019)

105 000

x 8/12 months =

70 000

Maintenance (section 11(d)) (prepaid for 10 months after Feb 2019)

40 500

x 10/12 months =

33 750

475 500 213 750

Note the following:

The R330 000, R105 000 and R40 500 have actually been incurred.

The prepaid amount for rent relates to a period of 4 months after year-end; therefore it will not be subject to section 23H and the full amount of R330 000 may be claimed in the 2019 year of assessment even though the prepaid portion is R110 000 (which is > R100 000).

Both of the other prepaid amounts (R70 000 and R33 750) relate to a benefit, which will be enjoyed over a period exceeding 6 months after year-end.

In terms of proviso (bb) to section 23H, the deduction of the R105 000 in terms of section 11(a) and R40 500 in terms of section 11(d) will be limited as the aggregate of the prepaid amounts (not otherwise limited by the section) exceeds R100 000, namely R103 750 (R70 000 + R33 750). Only the portion which was enjoyed during the 2019 year of assessment will be deductible in the 2019 year of assessment.

Therefore, deductible for Income Tax purposes in the 2019 year of assessment is the full amount of rent paid (R330 000), R35 000 (i.e. R105 000 – R70 000 or R105 000 x 4/12 months) in terms of section 11(a) (insurance) and R6 750 (i.e. R40 500 – R33 750 or R40 500 x 2/12 months) in terms of section 11(d) (maintenance).

The prepaid portions of R70 000 and R33 750 will be deductible in the following (2020) year of assessment in terms of section 11(a) and 11(d), respectively.

However, if the insurance were, for example, prepaid for 7 months of 2019 in the above example and the maintenance were prepaid for 8 months of 2019, the aggregate of the prepaid amounts (not otherwise limited by the section) would not exceed R100 000:

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R 61 250 (R105 000 x 7/12 months) + R27 000 (R40 500 x 8/12 months) = R88 250 and the full R105 000 and R40 500 would accordingly be deductible in terms of section 11(a) and section 11(d), respectively.

8.7.4 Tax treatment of leases versus suspensive sale agreements

Although not specifically included in this learning unit, we feel that it will add value to incorporate a table to explain the different tax treatments of leases and suspensive sale agreements. Study the table provided.

The most important difference between leases and suspensive sale agreements for normal tax purposes is the fact that a lease (finance lease or operating lease) is treated as a rental agreement for normal tax purposes, while a suspensive sale agreement is treated as a sale for normal tax purposes.

Leases versus suspensive sale agreements table

Lease (operating or finance lease)

Suspensive (instalment) sale agreement

Lessor Seller

Income Tax

Taxed on instalments (remember to exclude VAT) received or accrued during the year of assessment.

Include lease premium and leasehold improve-ments (an obligation to effect) in gross income in terms of paragraphs (g) & (h) to the gross income definition (remember possible relief in terms of section 11(h)).

The lessor may claim capital allowances (sections 12C, 13(1), 13quin, 13sex or 11(e)), if applicable, on original cost of the asset.

Claim other related expenses in terms of section 11(a).

Remember the possible application of sec-tions 23A and 23D.

Income Tax

Sale of asset (trading stock) Selling price included in gross income (excluding finance cost and VAT) less cost of sales (deducted as purchase price or opening stock).

Sale of asset (allowance asset) Recoupment included in taxable income

Sale of asset (capital asset) Capital gain or loss aggregated with other capital gains or losses and any aggregate capital gain is included in taxable income at the relevant inclusion rate of the taxpayer.

Finance cost included in gross income, spread over the period of the agreement in terms of section 24J.

Possible section 24 allowance available on out-standing debtor’s balance.

VAT

Lease agreement (finance lease) – Treated as an instalment credit agreement. Account for full amount of VAT on receipt of any payment or delivery of goods.

Rental agreement (operating lease) – Account for output tax on earlier of date that payment is due or payment is received.

VAT

Instalment credit agreement, therefore pay full amount of VAT on receipt of any payment or delivery of goods.

(Note: VAT treatment same for finance lease and suspensive sale)

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Lessee Buyer

Income Tax

As a lease, deduct amount actually incurred in terms of section 11(a) (full instalment – remember to exclude VAT).

Deduct lease premium in terms of section 11(f) and leasehold improvements in terms of section 11(g). Remember, excess improve-ments could be deductible in terms of section 13(1).

At the termination of lease, remember possible section 8(5) recoupment.

Income Tax

Bought an asset capitalise asset (excluding VAT) and claim capital allowance on purchase price.

Claim finance cost in terms of section 24J.

VAT

Lease agreement (finance lease) – Claim full amount of input tax if in possession of a valid tax invoice (same time of supply rules as for the lessor).

Rental agreement (operating lease) – Claim VAT on each instalment (same time of supply rules as above for the lessor).

VAT

Claim full amount of VAT if in possession of valid tax invoice.

(Note: VAT treatment same for finance lease and suspensive sale)

8.8 OUTCOMES OF THE BEANCOUNTER SCENARIO

You have studied LU 8 and should now be able to answer Bizzie Beancounter’s queries. Read through the Beancounter scenario again and make a rough summary of what your solution would be.

Although it was not specifically required, we provide you with references to the Income Tax Act in the solution for study purposes.

In formulating your answer, you should have identified the following:

Bizzie trades in her own name and you should explain to her that she will be taxed in her own name on the taxable income of Bizzie-as-a-bee Cleaners. Bizzie’s year of assessment runs from 1 March 2018 to 28 February 2019. Bizzie commenced her trading activities on 15 May 2018. A dry-cleaning business is a “trade” as defined, therefore she will be allowed to deduct all allowable expenses (excluding VAT) incurred from this date onwards, from the income derived out of the business. These deductions are allowed in terms of either the general deduction formula (e.g. rental paid, water and electricity, salaries, interest paid) or specific deductions provided for in the Income Tax Act (e.g. bad debt, key-man policies etc.). She will be entitled to the following deductions in respect of the expenses and losses which she incurred:

Expenses incurred prior to 15 May 2018 in preparation of the carrying on of her dry-cleaning business, can be deducted in terms of section 11A in the year of assessment in which she commences trading (being her 2019 tax year), provided such expenses would have been deductible had they been incurred after trading commenced. The section 11A deduction is, however, limited to the trade income after deducting any amounts deductible in that year of assessment in terms of any other provisions of the Income Tax Act. The excess deductions may be carried forward for possible deduction in the next year of assessment against income from the dry-cleaning business.

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The rent paid for the period 1 June 2018 until 28 February 2019 (9 months) is deductible in terms of

section 11(a). The portion for the period 1 March 2019 until 31 May 2019 (3 months) is also deductible in terms of section 11(a), but read with section 23H. The prohibition in section 23H is not applicable as the pre-paid period is less than 6 months after year end. Therefore, the amount of the pre-paid portion is not relevant to the facts provided.

The monthly cash salaries are deductible in terms of section 11(a).

The medical aid fund contributions paid by Bizzie for the benefit of her employees is deductible in terms of section 11(a) as long as it meets the requirements of that section. The amount deductible is not limited. Take note that it is not deductible in terms of section 11(l), which now only allows for the deduction of contributions made by the employer on behalf of an employee to a retirement fund.

The medical aid fund contributions paid by Bizzie for the benefit of her employees are paid in terms of the contract with the medical aid fund and therefore do not constitute the discharge of a debt of the employees, but it is a contribution for the benefit of the employee to a medical aid fund and therefore a fringe benefit in the hands of the employee in terms of para 2(i) and 12A of the Seventh Schedule to the Income Tax Act. (This is provided for study purposes only as it was not part of the required. It will be addressed in more detail in TL107).

Bizzie is trading in her own name. The net income or loss of the business will be added to all Bizzie’s other income and any taxable capital gains which she might have earned or realised during the year of assessment. If the loss from the business has the effect that she has an assessed loss instead of a taxable income for the current year of assessment, this loss will be carried forward to the following year of assessment in terms of section 20 of the Income Tax Act. The stipulations of section 20A must also be taken into account. Section 20A, however, is only applicable if Bizzie earns an amount of taxable income, excluding the dry cleaning business, where the maximum marginal rate becomes applicable (R1.5 million for the February 2019 year of assessment); or if the dry cleaning business is a suspect trade. Refer to Silke par 7.1.1 for more detail on this.

END OF LEARNING UNIT 8

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9 CAPITAL ALLOWANCES AND RECOUPMENTS

WORK PLAN FOR 29 and 30 MARCH 2019 (DAY 3 & 4)


A total of 11 hours (3 hours + 8 hours) of your study time this week has been allocated to LU 9. The following time allocation is recommended:

Topic Minutes

Important definitions 20

Allowances on movable assets 40

Allowances on immovable assets 120

Leases 120

Intellectual property 30

Recoupments and debt reduction (debt benefit) 180

Alienation, loss or destruction allowance 60

Comprehensive examples 13.44 & 13.45 in SILKE par 13.13 90

Total 660

The above time allocation is only an indication. The amount of time you need to spend on each topic will be greatly influenced by the knowledge you already have from undergraduate and previous postgraduate studies. You should therefore adapt the time allocation wherever necessary to suit your level of prior knowledge.

9.2 BACKGROUND LU 9 This LU deals with capital allowances available as deductions against income and the related recoupments, which are included in gross income (in terms of paragraph (n)). It also deals with the concession or compromise in respect of debt (previously, referred to as reduction of debt (section 19)), the allowance in respect of disposal of assets (section 11(o)), the limitation of losses from the disposal of certain assets (section 20B) and the incurral and accrual of amounts in respect of assets acquired or disposed of for unquantified amounts (section 24M).

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This learning unit is very important as it will be tested in the exam and has previously been included in the SAICA ITC examination. TAX FRAMEWORK The topics covered in this learning unit fit into the tax framework as follows:

GROSS INCOME (section 1) LESS: Exempt income (sections 10 and 10A to 10C) = INCOME LESS: Deductions and allowances (sections 11 – 24P, excluding s 18A & s 20) LESS: Assessed loss brought forward (section 20) ADD: Amounts to be included in taxable income including TAXABLE CAPITAL GAINS LESS: Qualifying donations (section 18A) = TAXABLE INCOME Use taxable income to calculate NORMAL TAX PAYABLE.


After studying LU 9, you should be able to meet all the outcomes listed at the beginning of chapter 13 of SILKE and understand and apply the CGT treatment of involuntary and voluntary disposals.

The most important outcome, however, is that you should be able to answer case study and integrated questions similar to those provided in sections B, C & D of this tutorial letter.

9.4 BEANCOUNTER SCENARIO Bizzie-as-a-bee Cleaners is now in full operation. Bizzie has acquired a new dry-cleaning machine, a delivery van, a computer and some furniture for the reception area. All these assets were bought from VAT vendors.

Bizzie wants to know which tax allowances and deductions she may claim in respect of the new assets that she purchased.

Before attempting to help Bizzie with her query, you should work through and master LU 9.


9.5.1 Study approach We provide you with a Table of Reference which contains the references to all the sections which must be studied in this learning unit together with a reference to the relevant paragraph in SILKE and a reference to additional notes provided (if any) in the tutorial letter.

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9.5.2 Table of Reference As mentioned above, the following table contains references to all the sections of the Income Tax Act that must be studied in this learning unit together with a reference to the relevant paragraph in SILKE and a reference to additional notes provided in the tutorial letter (if any), as well as an indication of whether a specific section is examinable or not. Download the relevant Interpretation Notes from the following link: http://www.sars.gov.za/Legal/Interpretation-Rulings/Interpretation-Notes/Pages/default.aspx (Relevant extracts of interpretation notes will be included in your assessments.)


Tax Act Topics

Reference to SILKE


TL Examinable

DAY 3 (3 hours)

SILKE: Overview 13.1

Important definitions (15 minutes)

s 1

Definition of a connected person 13.2.1 Yes

Interpretation Note No. 67 (Issue 3): Connected persons.

Definition of machinery, plant, implements, utensils and articles

13.2.2 Yes

Definition of process of manufacture 13.2.3 Yes

Definition of depreciable asset 13.2.4 Yes

Cost of assets (5 minutes)

s 23C Cost of assets and VAT 6.9 Yes

Allowances on movable assets (40 minutes)

s 11(e) Wear-and-tear allowance

(Write-off periods (as per Interpretation Note No. 47) will be given in a question)

13.3.1 9.7.1, 9.7.3, 9.7.4 & 9.7.4.1

Yes

Interpretation Note No. 47 (Issue 3): Wear-and-tear or depreciation allowance (section 11(e)).

Excluding:

s 11(e)(iiiA)

No

s 12B Movable assets used in farming or production of renewable energy

13.3.2 No

s 12C Movable assets used by manufacturers, for research and ships and aircrafts.

Movable assets used by manufacturers for research and development or by hotel keepers and assets used for storage and packing of agricultural products.

Information will be provided as to whether a particular process is a manufacturing or similar process.

13.3.3 9.7.1, 9.7.3, 9.7.4 & 9.7.4.1

Yes


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Tax Act Topics

Reference to SILKE


TL Examinable

Excluding:

s 12C(1)(bA), (c), (d), (e), (gA) and proviso (d)

No

s 12E Small business corporations Information will be provided as to whether a particular process is a manufacturing or similar process

13.3.4 9.7.1, 9.7.3,

9.7.4.1 & 9.7.5

Yes

s 12DA Rolling stock 13.3.5 No

Allowances on immovable assets (120 minutes)

s 13 Buildings and improvements: Annual allowance Tax values and allowances of buildings erected prior to 1 January 1989 or during the 10% write-off period will be provided. Information will be provided as to whether a particular process is a manufacturing or similar process

13.4.1

9.7.1 & 9.7.6

Yes

Excluding:

S 13(8)

No

s 13quat Urban development zones 13.4.2 No

s 13sex Residential units 13.4.3 9.7.1 & 9.7.6

Yes

s 1 Definition of a residential unit 13.4.3 9.7.1 & 9.7.6

Yes

s 13sept Low-cost residential units on loan account 13.4.4 No

s 1 Definition of a low-cost residential unit 13.4.4 9.7.1 & 9.7.6

Yes

s 13quin Commercial buildings 13.4.5 9.7.1 & 9.7.6

Yes

S 12S Buildings in special economic zones 13.4.6 No

s 12D Pipelines, transmission lines and railway lines 13.4.7 No

s 12NA Deductions in respect of improvements on property in respect of which Government holds a right of use or occupation

13.4.8 No

Hotels and charters of aircraft and ships

s 13bis Immovable assets of hotels: Annual allowance on buildings

13.5.1 No

s 12C Hotels: Movable assets 13.5.2 No

s 33 Owners and charterers of aircraft or ships 13.6 No

s 12Q Exemption of income in respect of ships used in international shipping

13.6.1 No

s 12C &

12E

Movable assets: Aircraft and ships 13.6.1 Yes

s 12F Immovable assets: Airport and port assets 13.6.2 No

DAY 4 (8 hours)

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Tax Act Topics

Reference to SILKE


TL Examinable

Leases (120 minutes)

s 11(f) Lease premiums 13.7.1 9.7.2 Yes

Excluding:

S 11(f)(v), (vi) & proviso (dd) & (ee)

No

s 11(g) Leasehold improvements 13.7.2 9.7.2 Yes

s 11(h) Relief for the lessor (lessor’s special allowance)

Amount will be provided in question

13.7.3 Yes

s 12N Deductions in respect of improvements not owned by the taxpayer

Excluding Public Private Partnerships and Independent Power Producer Procurement Programme

13.7.4 9.7.2 Yes

s 23A Limitation of allowances for lessors of certain assets

13.7.5 No

s 23D Sale and leaseback arrangements 13.7.6 9.7.7 Yes

s 23G Sale and leaseback arrangements (tax-exempt bodies)

13.7.6 No

Intellectual property (30 minutes)

s 11(gA) Acquisitions and registration of intellectual property before 1 January 2004

No

s 11(gB) Granting, renewal and registration of intellectual property

13.8.1 9.7.8 Yes

s 11(gC) Acquisition of patents, designs, copyrights or other similar property (not a trade mark)

13.8.1 9.7.8 Yes

s 11D Deductions in respect of scientific or technological research and development

13.8.1 No

s 23I Prohibitions of deductions in respect of certain intellectual property

13.8.1 No

Allowances on other types of assets

s 11(gD) Government business licences 13.9.1 No

s 12I Industrial policy project allowance 13.9.2 No

s 12L Energy efficiency savings deduction 13.9.3 No

s 12U Additional deduction for roads and fences used in respect of the production of renewable energy

13.9.4 No

s 37B Environmental expenditure 13.9.5 No

s 37C Environmental conservation and maintenance 13.9.6 No

s 37D Land conservation in respect of nature reserves and national parks

13.9.7 No

Recoupments and concession or compromise regarding debt (180 minutes)

s 8(4)(a) Recoupments: General recoupment

provision

13.10.1 Yes

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Tax Act Topics

Reference to SILKE


TL Examinable

s 8(4)(b) Actuarial surplus paid from a pension fund 13.10.1 No

s 24M Incurral and accrual of amounts in respect of assets acquired or disposed of for unquantified amount

13.10.1 & 6.3.2.1

9.7.10 Yes

s 8(4)(k) Recoupments: Donations, asset in specie distributions or the disposal of assets to connected persons

13.10.2 Yes

s 8(4)(e) – (eE)

Recoupments: Deferred recoupment of allowances

13.10.3 Yes

Par 65 of 8th Schedule

Roll-overs: Involuntary disposals 17.10.3.1 Yes

Par 66 of 8th Schedule

Roll-overs: Reinvestment in replacement assets

17.10.3.2 Yes

s 8(4)(l) Recoupments: Interest or related finance charges

13.10.4 No

s 8(4)(n) Recoupments: Industrial policy project allowance

13.10.5 No

s 8(4A) Recoupments: Deemed allowance No

s 8(5) Recoupments: Acquisition of hired assets 13.10.6 9.7.9 Yes

s 19 Recoupments: Concession or compromise regarding a debt (previously reduction or cancellation of debt).

13.10.7 Yes

Alienation, loss or destruction allowance (scrapping allowance) (60 minutes)

s 11(o)

Alienation, loss or destruction allowance

(previously scrapping allowance)

13.11 Yes

Interpretation Note No. 60 (Issue 2): Loss on disposal of qualifying depreciable asset.

s 20B

Limitation of losses from disposal of certain assets

13.11.1 Yes

Sundry provisions (Not covered in SILKE)

s 8(4)(f) Excess recoupment in respect of further (replacement) asset No

s 13ter Deductions in respect of residential buildings No

Comprehensive examples (90 minutes)

Do the comprehensive examples 13.44 & 13.45 in SILKE par 13.13.

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9.5.3 Parts of paragraphs in SILKE which you may ignore The following parts of paragraphs in SILKE may be ignored due to the fact that it deals with sections which are excluded from the syllabus:

Silke reference

Topic

13.2.2 & 13.2.3 Information will be provided as to whether a particular process is a manufacturing (or similar) process as defined

13.3.3 The part of the table that refers to agricultural co-operatives and hotelkeepers

13.5.1 Immovable assets of hotels

13.6 Owners and charterers of aircraft and ships (Part relating to s 33)

13.6.2 Immovable assets – airports and port assets

13.7.6 Reference to section 23G included in SILKE 13.7.6 may be ignored as section 23G is excluded from the SAICA syllabus

13.8.1 The part that deals with ss 11D and 23I (both sections excluded from the SAICA syllabus)

13.10.1 The part that refers to s 8(4)(b)

9.6 LAW AMENDMENTS


Section 12C Capital allowance for the process of manufacture

The spelling of the word “hotelkeeper” has been corrected to two words, “hotel keeper” and now aligns with its definition in section 1 of the Income Tax Act.

Section 12N Deductions in respect of improvements not owned by taxpayer

The superfluous reference to section 13bis has been deleted, because section 13bis does not require the taxpayer to be the owner of the building or improvement.

Section 19 Recoupments: Concession or compromise in respect of debt

Refer to the summary of the law amendments in TL 104/2019. In short, the following amendments have been promulgated in respect of section 19:

A new and more comprehensive definition of a “concession or compromise” has been inserted. The debt relief rules only apply to realisation events. Changes in the terms and conditions of a taxpayer’s debt arrangement will have no effect unless it results in a realisation event. Refer to the new definition in section 19.

In the case of debt to equity conversions, the debt relief provisions will only apply to interest-bearing debt and equity loans that are non-interest bearing are excluded. (Note that group debt that is interest-bearing and is converted to equity is also still excluded.)

The definition of a “debt benefit” has been amended – refer to the definition in section 19(1).

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Where there is an increase in the value of effective shareholding of the creditor in the debtor company as a result of a conversion of debt into shares, such increase will be applied to reduce the debt benefit.

A definition of “market value” has been inserted. The “market value” of the shares acquired must be determined immediately after the implementation of the concession or compromise.

The donations tax exclusion has been amended to provide that the exclusion is only available in the instance that donations tax is payable on a donation that arises from a debt benefit arrangement.

All the amendments (except for the donations tax exclusion) are deemed to have come into operation on 1 January 2018 and applicable in respect of years of assessment commencing on or after this date. The amendment relating to the donations tax applies in respect of years of assessment commencing on or after 1 January 2019.

9.7 NOTES ON CAPITAL ALLOWANCES AND RECOUPMENTS

For capital allowances a distinction should be made between assets which are purchased/acquired (see par 9.7.1 below) and assets which are rented/hired/leased (see note 9.7.2 below).

9.7.1 The acquisition of assets

The taxation rules relating to assets acquired by the taxpayer can be divided into three areas: the first area deals with the cost incurred that can be included in the cost of acquiring the asset, the second area deals with the rate of the allowances that can be claimed while the person is using the assets and the last area deals with the sale or disposal of the asset. The following table summarises the main sections of the Income Tax Act that deal with each of the above areas:

Topic Section

Acquisition of the asset (Cost price)

S 1: Definition of a connected person and depreciable asset

S 23C: Reducing the cost or market value of certain assets with input tax claimed

Ss 11(e), 12B, 12C, 12E: Cost determinations

VAT Act

Ss 24I and 25D: Foreign currency transactions (LU 11)

Use of the asset (Allowances)

S 11(e): Wear-and-tear allowance (read with Binding General Ruling No. 7 / Interpretation Note No. 47)

S 12C: Special wear-and-tear allowance

S 12E: Deductions in respect of a small business corporation

S 13: Deduction in respect of buildings used in a manufacturing process

S 13sex: Residential units

S 13sept: Sale of low-cost residential units on loan account

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Topic Section

S 13quin: Deduction in respect of commercial buildings

Ss 24I and 25D: Foreign currency transactions (LU 11)

Sale of the asset (Recoupment)

S 8(4)(a): General recoupment provision

S 8(4)(e), (eA), (eB), (eC), (eD) & (eE): Deferred recoupments

S 19: Concession or compromise in respect of debt

S 11(o): Alienation, loss or destruction allowance (previously scrapping allowance)

S 20B: Limitation of losses from disposal of certain assets

Eighth Schedule: CGT

Example: Capital allowances

The following simplified example can be used to explain capital allowances in the Income Tax Act:

A taxpayer, which is a manufacturer and a registered vendor (but not a small business corporation), acquires a second-hand manufacturing asset from a non-vendor for R1 000. The company used the asset for 3 months in Year 1 and 6 months in Year 2. Binding General Ruling No. 7 (Interpretation Note No. 47) allows taxpayers to claim wear-and-tear over a 5-year period on these assets. The taxpayer received R1 500 cash when it sold the asset in Year 2. Your friend gave the following answer in a test:

He failed the test, getting 0/10 for the answer above. Can you identify the mistakes he made?

As this is a second-hand asset, a deemed input tax can be claimed. Therefore, the cost of the asset should be R1 000 x 100/115 = R870 (section 23C).

The taxpayer is a manufacturer, but not a small business corporation. Therefore, the manufacturing asset acquired qualifies for section 12C and not section 11(e) read with Binding General Ruling No. 7 / Interpretation Note No. 47. As this is a second-hand asset, the asset qualifies for a 20% write-off per annum for 5 years.

The section 12C wear-and-tear allowance of 20% per annum is not apportioned. Therefore, in Year 1 and Year 2 the taxpayer will qualify for an allowance of R174 (R870 x 20% = R174).

As the taxpayer is a registered vendor and the asset is sold, the sale is subject to VAT. The amount received therefore includes VAT of R1 500 x 15/115 = R196, and the exclusive selling price is therefore R1 304.

The recoupment will be the selling price (excluding VAT; R1 304) less the tax value of R522 (R870 – R174 – R174), thus R782; however, remember that the recoupment is limited to allowances pre-viously claimed, namely R348 (R174 + R174).

As it is a capital asset being sold, the CGT provisions must be applied.

Remember, terminology is important when answering taxation questions. For example, you must use “base cost” and not cost when dealing with CGT.

Year 1: Wear-and-tear allowance (R1 000/5 years x 3/12) R 50 Year 2: Wear-and-tear allowance (R1 000/5 years x 6/12) R100 Recoupment (R1 500 – (R1 000 – R50 – R100)) R650

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The proceeds must be reduced by the amount included for Income Tax purposes (the recoupment). The proceeds = the selling price (R1 304) – recoupment (R348) = R956.

The base cost will be the cost incurred (R870) less the allowances claimed (R348) = R522.

The capital gain on the disposal of the asset will be R434 (R956 – R522). Remember that all the gains and losses for different assets must be added to calculate the taxable capital gain. Depending on the type of taxpayer, you will apply the annual exclusion (if applicable) and the relevant inclusion rate to determine the taxable capital gain.

Remember, whenever a capital asset is sold, even for less than the original cost, a capital gain must be calculated. Although the capital gain will be Rnil, the Income Tax Act still requires a calculation to be done and marks are awarded for the calculation.

9.7.2 Lease of assets (rented/hired/leased)

The deductions that the taxpayer (lessee) can qualify for when entering into a lease will depend on the nature of the amount being paid, for example

monthly rental (section 11(a))

lease premium (section 11(f))

leasehold improvements (section 11(g))

The amount of the leasehold improvements is included in the gross income (paragraph (h) of the gross income definition) of the lessor, subject to certain allowances. Always read the information carefully to determine if you are dealing with the lessee or lessor when answering a question.

A summary of the interaction between section 11(g) and section 12N

A taxpayer (lessee) must construct a building for R100 000 on leased land in terms of a contract. The actual cost amounted to R150 000.

S 11(g) S 12N S13(1) S 13quin

1 Factory and owner (lessor) of land is tax paying entity

R100 000 ÷ period

R2 500 (5% x R50 000)

2 Factory and owner (lessor) of land is tax exempt entity

Rnil (as tax exempt)

R7 500 (5% x R150 000)

3 Offices (commercial building) and owner (lessor) of land is tax paying entity

R100 000 ÷ period

Rnil (not owner)

4 Offices (commercial building) and owner (lessor) of land is tax exempt entity

Rnil (as tax exempt)

R7 500 (5% x R150 000)

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9.7.3 Movable assets

It is important to remember that the allowances which may be claimed depend not only on the type of asset used, but also on the status of the taxpayer (lessor) that owns it. These rules are mutually exclusive.

9.7.4 Sections 11(e) and 12C allowances summary (SILKE 13.3.1 & 13.3.3) In Silke (13.12.1) a summary (including a summary of section 13) is provided. The table below is more comprehensive.

Capital allowance

Section 12C

Wear-and-tear

Section 11(e)

_ Machinery and plant used directly in a manufacturing or similar process or for research and development purposes and also aircraft and ships including any improvements. (A question will indicate whether a process is a manufacturing or a similar process, in terms of the SAICA syllabus.) Where machinery, mounted onto a foundation, qualifies for the section 12C deduction, so too will the foundation (proviso to section 12C(1)). Available to the owner of that asset or the purchaser (under a suspensive sale agree-ment) of the asset.

_ Machinery, plant, implements, utensils and articles (that do not qualify for section 12B, section 12C or section 12E(1) (manufacturing assets of a small business corporation)); if the Commissioner is satisfied that the value of that asset has diminished through wear-and-tear. Applicable to movable assets only: no allowance for buildings or other permanent structures (except foundations and supporting structures if they are designed for the asset and have a similar useful life). Available to the owner of that asset or the pur-chaser (under a suspensive sale agreement) of the asset.

Machinery and plant, leased out by the taxpayer in terms of a financial (or operating) lease and used by the lessee directly in a manufacturing or similar process, also qualify. It is then the lessor who is entitled to the allowance. Note, however, the possible limitation in terms of sections 23A or 23D.

A lessor can claim wear-and-tear on assets leased in terms of a financial lease. Note, however, the possible limitation in terms of sections 23A or 23D.

New or used

Brought into use for the first time by the taxpayer or lessee for trade purposes.

Used for trade purposes by the taxpayer or lessee.

Calculated on cost, which is the lesser of actual cost or cost under a cash transaction concluded at arm’s length. No cost = no allowance. Cost includes direct cost (which includes shipping and delivery charges) of foundations, installation and erection.

Calculated on value, thus possible to claim wear-and-tear on an asset that has no cost. However, the practice is to use cost if available and applicable. Value is the direct cost of acquisition under a cash transaction concluded at arm’s length and includes shipping and delivery charges, cost of foundation or supporting structures and the direct cost of installation and erection, plus the cost of moving these assets from one location to another location (if not written off in terms of section 11(a)); otherwise use market value.

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Capital allowance

Section 12C

Wear-and-tear

Section 11(e)

Moving costs

Asset not yet written off – deduct over remaining years (including current year) in equal instalments.

Asset fully written off – deduct in full.

Moving costs Write off over the remaining write-off period of the asset.

Accelerated allowances (for new or unused plant and machinery only – thus not second-hand):

40/20/20/20% p.a. Not available to banking, financial services, insurance or rental busines-ses.

50/30/20% p.a. for new or unused machinery and plant used for research and development (excluded from syllabus this year).

_ In all other instances (thus used (i.e. second-hand) plant and machinery) – 20% p.a.

Period of write-off per Binding General Ruling No. 7 (Interpretation Note No. 47). Written application for other periods. (You will be provided with the number of years over which assets may be written off in terms of Binding General Ruling No. 7 / Interpretation Note No. 47).

Small items: If the value of the item (not forming part of a set) < R7 000, it can be written off to R1 in the year of acquisition.

Assets written off in full must be shown at R1.

Straight-line basis. Written off over useful life = straight-line.

Start deducting in year in which asset is brought into use.

No apportionment for part of the year (thus allowance is allowed in full).

Apportion where used for part of the year.

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A comparison of the movable asset allowances in sections 11(e), 12C and 12E

Section 11(e) (Silke 13.3.1) Section 12C (Silke 13.3.3) Section 12E (Silke 13.3.4)

Not applicable to: - manufacturing assets of small business corporations (SBC) - assets that qualify for s 12C

Manufacturers (excluding SBC), ships, aircraft

SBC

All movable assets, except where s12B (Silke 13.3.2), s12C or s 12E applies

Machinery or plant used in a process of manufacture (or similar process) except for SBC

All assets of SBC

Mostly movable non-manufacturing assets, including non-manufacturing assets of manufacturing enterprises

Only the manufacturing assets of manufacturing enterprises (not assets like the office equipment, vehicles etc.) - new or used and brought into use for the first time by the taxpayer.

Manufacturing assets – new or used and brought into use for the first time by the taxpayer and Non-manufacturing (Sec 12(1A))

Apportion (pro-rata) No apportionment (not pro-rata)

Loose assets < R7 000 written off to R1

Write-off periods – Binding General Ruling No. 7 / Interpretation Note No. 47 Written-off to R1

New / unused – 40/20/20/20% Used – 20/20/20/20/20%

Manufacturing assets - 100% Non-manufacturing assets - 50/30/20% Section 11(e) may be elected on non-manufacturing assets (loose assets/tools <R7 000 may be written-off to R1)

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The following diagram may assist you in deciding which allowances may be claimed:

9.7.5 Section 12E – deduction in respect of the assets of a small business corporation (SILKE par 13.3.4)

In the case of non-manufacturing assets acquired by a small business corporation, the personal liability company; entity or corporation may elect to write off the asset in terms of

section 11(e), or

section 12E(1A) – 50% of the cost of the asset in the year during which the asset was brought into use for the first time, 30% of the cost in the second year and 20% of the cost in the third year (50/30/20).

Note that, for example, in the case of assets with a cost of less than R7 000, it will be to the benefit of the taxpayer to elect section 11(e), as opposed to section 12E(1A) as amounts less than R7 000 can be written off to R1 (in terms of Binding General Ruling No. 7 / Interpretation Note No. 47) in the first year during which the asset is brought into use. This option is, however, not available for manufacturing assets which must be written off in terms of section 12E(1) or when not dealing with a small business corporation, section 12C must be used.

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9.7.6 Immovable assets A concise summary of the allowances on immovable property is included below:

IMMOVABLE PROPERTY ALLOWANCES

Section 13 Section 13quin Section 13sex

Manufacturing buildings (factories)

Commercial buildings (offices and shops)

Residential units (Must own at least 5 units)

Erected by the taxpayer OR

purchased from a person entitled to the allowance (second hand)

OR purchased as a new building

New and unused (Erected by the taxpayer

OR purchased as a new

building)

New and unused (Erected by the taxpayer

OR purchased as a new

building)

Owned OR

on excess leasehold improvements OR

on section 12N leasehold improvements (1 Jan 2013)

Owned OR

on section 12N leasehold improvements

(1 Jan 2013)

Owned OR

on section 12N leasehold improvements (1 Jan 2013)

Used wholly or mainly in the production of income and for purposes of trade

From 1 October 1999 (Manufacturing) From 1 April 2007 From 21 October 2008

5% 5%

5% on residential units

10% on low-cost residential units

Calculate on COST less any deferred recoupment and portion deductible as leasehold

improvements Calculate on COST

Cost = cost to the taxpayer Cost = lesser of actual cost incurred or market value if

purchased

Cost = 100% of the cost of erection or cost of acquisition or cost of acquisition of improvement

Cost = 100% of the cost of erection or acquisition OR 55% of cost if part is acquired OR 30% of cost of

acquisition of improvement

9.7.7 Summary of section 23D (SILKE 13.7.6) We have summarised section 23D in the table below (Section 23G (Sale and leaseback arrangements with exempt entities) does not form part of the SAICA syllabus.) The table below summarises section 23D. Remember that for Income Tax purposes, a lessor is only entitled to a capital allowance where the asset is leased out under either a lease agreement (finance lease) or a rental agreement (operating lease). Where an item is sold under a suspensive sale agreement, the seller cannot claim this capital allowance. In this regard, also refer to the table comparing the tax treatment of leases versus suspensive sale agreements in note 8.7.4 above.

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Section 23D

Limitation of allowances granted to lessors in sale and leaseback arrangements or a licenser who licenses a depreciable asset back to the

person who disposed of it to him/her (now the licensee).

Applicable to Lessors (in sale and leaseback arrangements) or licenser of depreciable assets.

Limitation Any deductions or allowances claimed by the lessor or licenser will be calculated on the purchase price of the depreciable asset, but always limited to

the cost to the lessee or licensee less

all deductions allowed to the lessee or licensee plus

any recoupment on the sale by the lessee or licensee plus

the taxable capital gain included in the taxable income of the lessee or licensee.

Definitions Depreciable asset (section 1)

An asset as defined in the Eighth Schedule (property of whatever nature, ex-cluding currency, and a right or interest in any property) that qualifies for a deduction or allowance that is in whole or partially based on its cost or value,

but excluding trading stock or any debt.

Examples SILKE example 13.21

9.7.8 Intellectual property (sections 11(gB) and 11(gC) and SILKE 13.8.1

Section 11D is excluded from the syllabus.

When studying the legislation regarding intellectual property, note the following:

Section 11(gB) allows for the deduction of the registration or renewal of registration expenses on intellectual property, including trade marks.

Section 11(gC) allows for the deduction of the acquisition costs of intellectual property, excluding trade marks. Only study the part relating to expenditure incurred on or after 1 January 2014.

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9.7.9 Recoupment: acquisition of hired assets (section 8(5) and SILKE 13.10.6) The diagram below may assist you in understanding the provisions of section 8(5) relating to leased assets.

Work through Example 13.36(1) – 13.36(4) in SILKE 13.10.6.

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9.7.10 Unquantified amounts (section 24M, par 39A of the 8th Schedule and SILKE 6.3.2.1, 13.10.1 and 17.9.4)

Section 24M (incurral and accrual of amounts in respect of assets acquired or disposed of for unquantified amounts) applies to three types of assets (namely):

disposal of non-depreciable capital assets; disposal of depreciable capital assets; and disposal of trading stock.

The first two will be discussed here and disposal of trading stock will be discussed in LU 10.

Disposal of non-depreciable capital assets

The seller determines capital gains/losses during the initial year of disposal under normal CGT rules, except that the proceeds for the initial year are taken into account only to the extent that those amounts can be fully quantified. This calculation triggers an initial capital gain or loss. However, in terms of paragraph 39A(1) of the Eighth Schedule, initial capital losses are disregarded (i.e. suspended) during that year. The seller must then account for further consideration in later years as that consideration becomes quantified (fully due and payable). This further consideration generates capital gains during each year of assessment without any base cost offset (paragraph 3(b)(i) of the Eighth Schedule). However, the seller reduces this gain to the extent of any remaining disregarded losses stemming from the initial year of disposal (paragraph 39A(2) of the Eighth Schedule). If any disregarded losses still exist once no further proceeds will accrue, these remaining capital losses can be fully accounted for at that time (paragraph 39A(3) of the Eighth Schedule).

If a person acquires assets for consideration that wholly or partly includes unquantified amounts, the expenditure incurred (base cost) is accumulated over time. However, future quantified amounts will be viewed as immediately incurred. More specifically, the person who acquires the asset is initially viewed as having incurred expenditure to the extent of the quantified consideration provided on disposal. Further expenditure is added to the disposed asset as further amounts become quantified. If the person who acquires the asset sells an asset before all amounts are quantified, the gain on the disposal is calculated without reference to the unquantified amounts. However, further quantified amounts incurred with regard to the disposed asset will generate capital losses as those are incurred (paragraph 4(b)(ii)) of the Eighth Schedule). Refer to the following examples adapted from the Explanatory Memorandum on the Revenue Laws Amendment Bill, 2004, which have been included to assist you in understanding the application and implications of section 24M, as well as the interaction of section 24M with the rest of the Income Tax Act.

Illustrative example: Gain on unquantified amounts

Individual A acquired retail property in December 2011 for R250 000. In March 2014, individual A sells all the retail property to individual B. In terms of the contract, individual B must pay 10% of the profits generated by the retail property to individual A for 5 years subsequent. Assume the amounts received are eventually R300 000, R200 000, R150 000, R110 000 and R240 000, starting the end of February 2015.

Result: The special rules of section 24M apply because unquantified payments are involved. Under the open transaction method, the initial 2015 year will trigger a small R50 000 gain for individual A. Subse-quent years will trigger additional capital gains. The net cumulative capital gain will amount to R750 000 (R1 million proceeds less the R250 000 base cost). Individual B’s base cost in the retail property acquired is accumulated over the 5 years as and when individual B pays individual A. Hence, individual B will have a R300 000 base cost in the first year, R500 000 in the second year, etc.

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Result for individual A (seller)

2015 2016 2017 2018 2019 R R R R R

Current receipts 300 000 200 000 150 000 110 000 240 000 Base cost: (250 000)

Gain/(loss) 50 000 200 000 150 000 110 000 240 000 Suspended loss

Taxable gain 50 000 200 000 150 000 110 000 240 000

Illustrative example: Overall gain on unquantified amounts after suspended loss

Individual A acquired retail property in December 2012 for R500 000. In March 2014, individual A sells all the retail property to individual B. In terms of the contract, Individual B must pay 10% of the profits generated by the retail property to individual A for 5 years subsequent. Assume the amounts received are eventually R300 000, R200 000, R150 000, R110 000 and R240 000, starting the end of February 2015.

Result: The special rules of section 24M apply because unquantified payments are involved. Under the open transaction method, the initial 2015 year will trigger a R200 000 suspended loss for individual A. Subsequent years will trigger capital gains that will first be used against the suspended loss. The net cumulative capital gain will amount to R500 000 (aggregated R1 million proceeds less the R500 000 base cost). Individual B’s base cost in the retail property acquired is accumulated over the 5 years as and when individual B pays individual A. Hence, individual B will have a R300 000 base cost in the first year, R500 000 in the second year, etc. Result for individual A (seller)

2015 2016 2017 2018 2019 R R R R R

Current receipts 300 000 200 000 150 000 110 000 240 000 Base cost: (500 000)

Gain/(loss) 200 000 150 000 110 000 240 000 Suspended loss (200 000) (200 000)

Taxable gain 0 0 150 000 110 000 240 000

Disposals of depreciable capital assets

Note that, if an asset which falls within the ambit of section 24M is sold and a recoupment should be calculated by the seller in terms of section 8(4) or a loss in terms of section 11(o) of the Income Tax Act, this recoupment or loss should be calculated with reference to the amounts already received by or accrued to the taxpayer in terms of section 24M (therefore only amounts quantified at that stage). Section 20B, in conjunction with section 24M, provide for the suspension of a loss made in terms of section 11(o) on a section 24M transaction (where unquantified amounts are involved – section 20B(1)). The suspended section 11(o) loss will be offset against future payments (section 20B(2)) and will only be realised once all payments are received. A recoupment in terms of section 8(4) will, however, be accounted for as soon as it is realised.

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The buyer will accumulate his base cost (or cost price) over time as and when amounts are quantified. This poses a problem for the calculation of wear-and-tear. Wear-and-tear should be calculated taking into account only quantified amounts and if an amount is received in a subsequent year after the asset was already brought into use, wear-and-tear should be calculated on that amount retrospectively, taking into account all the years for which the asset had been in use.

Work through the example, adapted from the Explanatory Memorandum on the Revenue Laws Amend-ment Bill, 2004, below.

Illustrative example

Company A (with a 31 March year-end) acquired a manufacturing machine in June 2014 at a cost of R500 000 and immediately brought it into use. After depreciating the machine by R200 000 (s 12C at 40%), company A sells the machine to company B (also with a March year-end) on 31 March 2015. Under the terms of the contract, company B must pay 10% of the value of the products produced by the machine for 5 subsequent years. Assume the amounts eventually received are R190 000, R40 000, R250 000, R280 000 and R240 000, starting on 31 March 2015.

Suggested solution

The special rules of section 24M apply because unquantified payments are involved.

Seller – Company A

N1 Net tax effect of transaction

Selling price = R1 000 000 (R190 000 + R40 000 + R250 000 + R280 000 + R240 000) Cost price = R500 000 Tax value = R300 000 (R500 000 – R200 000)

N2 Total s 8(4)(a) recoupment for the transaction

= R500 000 (R1 000 000 limited to cost) – R300 000 (tax value (N1)) = R200 000

N3 Total capital gain (Eighth Schedule)

Proceeds of R800 000 (R1 000 000 – R200 000 (s 8(4)(a))) Less: Base cost of R300 000 (R500 000 – R200 000 (s 12C allowance)) = R500 000

N4 S 20B, in conjunction with s 24M, provides for the suspension of a loss made in terms of s 11(o) on a s 24M transaction (s 20B(1)). The suspended loss will be offset against future payments (s 20B(2)) and will only be realised once all payments are received.

N5 R480 000 (R190 000 + R40 000 + R250 000) – R300 000 (tax value) = R180 000 N6 R760 000 (R480 000 + R280 000) limited to cost price = R500 000 – R300 000 = R200 000, but

R180 000 accounted for in 2017, therefore R20 000 recoupment (or R500 000 – R480 000). Capital gain: R760 000 – R500 000 = R260 000 (or proceeds R560 000 (R760 000 – R200 000 (recoupment)) – base cost R300 000 (R500 000 – R200 000 (wear-and-tear)) = R260 000).

N7 Total s 12C allowance claimed over the 5 years equals the total cost of R1 000 000

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Seller – Company A

Tax treatment in terms of section 24M

2015 2016 2017 2018 2019

R R R R R Current receipts 190 000 40 000 250 000 280 000 240 000 Less: Tax value (500’ – 200’)

(300 000)

-

-

-

-

Gain/loss (110 000) 40 000 250 000 280 000 240 000

Suspended s 11(o) loss N4

(110 000)

(70 000)

(110’ – 40’)

0

(70’ – 70’)

0

0

Recoupment N2 (s 8(4)(a))

N5 180 000 (250’ – 70’)

N6 20 000 0

Capital gain N3 N6 260 000 240 000

Buyer – Company B

2015 2016 2017 2018 2019 R R R R R

Current payments

190 000 40 000 250 000 280 000 240 000

Base cost: 190 000 230 000 480 000 760 000 1 000 000 (s 12C) N7 38 000 54 000 196 000 320 000 392 000

R190 000 38 000 (20%)

38 000 (20%)

38 000 (20%)

38 000 (20%)

38 000 (20%)

R40 000 16 000 (40%)

8 000 (20%)

8 000 (20%)

8 000 (20%)

R250 000 150 000 (60%)

50 000 (20%)

50 000 (20%)

R280 000 224 000 (80%)

56 000 (20%)

R240 000 240 000 (100%)

S 12C allowance (second-

hand)

20% 20% 20% 20% 20%

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9.8 OUTCOMES OF THE BEANCOUNTER SCENARIO

You have studied LU 9 and should now be able to answer Bizzie Beancounter’s queries. Read through the Beancounter scenario again and make a rough summary of what your solution would be.

You need not provide detailed references to specific sections, but rather just a list of all the different provisions which will have an effect on Bizzie Beancounter’s queries.


Bizzie currently trades in her own name. She will be entitled to the following capital allowances in respect of the assets she acquired for trade purposes:

Dry-cleaning is a process similar to a process of manufacture. Therefore, she will be entitled to a section 12C capital allowance on the dry-cleaning machine. This will be calculated at 40/20/20/20% on the cost price (excluding VAT) with no apportionment for part of a year.

The delivery van, computer and furniture will qualify for wear-and-tear in terms of section 11(e). The cost price of the assets (excluding VAT) will be written off to R1 over the useful life of the assets in terms of Binding General Ruling No. 7 (Interpretation Note No. 47). Small items costing less than R7 000 can be written off to R1 in the year of acquisition. The allowance is calculated on the straight-line basis with apportionment for part of a year.

You should explain to Bizzie that she will be taxed in her own name on the taxable income of Bizzie-as-a-bee Cleaners. Furthermore, only 40% of her net capital gains, after deducting the annual exclusion of R40 000, will be included in her taxable income.


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10 TRADING STOCK

WORK PLAN FOR 31 MARCH 2019 (DAY 5)


A total of 2 hours of your study time this weekend has been allocated to LU 10. The following time allocation is recommended:

Topic hours

Trading stock 2

The above time allocation is an indication only. The amount of time you need to spend on each topic will be greatly influenced by the knowledge you already have from undergraduate and previous postgraduate studies. You should therefore adapt the time allocation wherever necessary to suit your level of prior knowledge.

10.2 BACKGROUND LU 10 LU 10 covers trading stock (sections 22 and 23F), which has an impact on almost all the elements of the tax framework. Section 9C is also dealt with in LU 10. TAX FRAMEWORK The topics covered in this learning unit fit into the tax framework as follows:

GROSS INCOME (section 1) LESS: Exempt income (sections 10 and 10A to 10C) = INCOME LESS: Deductions and allowances (sections 11 – 24P, excluding s 18A & s 20) LESS: Assessed loss brought forward (section 20) ADD: Amounts to be included in taxable income including TAXABLE CAPITAL GAINS LESS: Qualifying donations (section 18A) = TAXABLE INCOME Use taxable income to calculate NORMAL TAX PAYABLE.

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After studying this learning unit, you should be able to meet the relevant outcomes listed at the beginning of the SILKE chapters covered in this learning unit. The most important outcome, however, is that you should be able to answer the case study and integrated questions similar to those provided in sections B, C & D of this tutorial letter.

10.4 BEANCOUNTER SCENARIO Remember that Bizzie is trading as a sole trader. She does the books for her business herself on a program called Chinese Books.

Bizzie began selling organic laundry detergent, in January 2019, that she purchases wholesale from Naturally Clean (Pty) Ltd, a VAT vendor (all amounts exclude VAT). She has approached you to assist her to calculate and explain the effect on taxable income of the following transactions: a) Trading stock (organic laundry detergent) with a cost of R500, was removed by Bizzie for private use.

The market value of the trading stock on the date it was removed and used was R900.

b) Trading stock (organic laundry detergent) with a cost of R400, was used by Bizzie in the dry-cleaning business (trade purposes). The market value of the trading stock on the date it was used was R750.

c) Trading stock (organic laundry detergent) with a cost of R1 000, was donated to a qualified PBO and a valid s 18A receipt was obtained. The market value of the trading stock on the date it was donated was R1 500.

Silke example 14.5 adapted

Before attempting to help Bizzie with her query, work through and master LU 10.


10.5.1 Study approach We provide you with a Table of Reference which contains the references to all the sections which must be studied in this learning unit together with a reference to the relevant paragraph in SILKE and a reference to additional notes provided (if any) in the tutorial letter.

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10.5.2 Table of Reference As mentioned above, the following table contains references to all the sections of the Income Tax Act that must be studied in this learning unit together with a reference to the relevant paragraph in SILKE and a reference to additional notes provided in the tutorial letter (if any), as well as an indication of whether a specific section is examinable or not. Download the relevant Interpretation Notes from the following link: http://www.sars.gov.za/Legal/Interpretation-Rulings/Interpretation-Notes/Pages/default.aspx (Relevant extracts of interpretation notes will be included in your assessments.)

Reference to the

Income Tax Act

Topics Reference to SILKE

Reference to notes in TL Examinable

DAY 5 (2 hours)

Trading stock (120 minutes)

s 1

Trading stock and deemed trading stock Definitions - Trading stock

- Gross income par (jA)

14.1(& 4.13)

10.7.1 Yes

s 22 Amounts to be taken into account in respect of values of trading stock - Closing stock

- Opening stock

- Cost price of trading stock

- Trading stock for no consideration

- Trading stock distributed as a dividend in specie

Excluding: s 22(1)(b), 22(3)(a)(iii)(aa) & (bb), 22(8) proviso (c), see further below for other subsections excluded

14.2, 14.3, 14.4, 14.5,

14.6

10.7.1 & 10.7.2

Yes

Interpretation Note No. 65 (issue 3): Trading stock – Inclusion in income when applied, distributed or disposed of otherwise than in the ordinary course of trade

Case law: - Ernst Bester Trust v CSARS

- Eveready (Pty) Ltd v CSARS

TL102 Yes

s 23F Acquisition or disposal of trading stock Anti-avoidance provisions

14.7 10.7.3 Yes

Excluding: s 23F(2) – (3)

No

s 22(1A) Deemed reduction of the cost of closing stock by sales tax amount

No

s 22(2A) & 22(3A)

Contractor’s work-in-progress 14.8 No

s 22(4A), (4B) & (9)

Securities lending arrangements 14.9 No

s 9C Deemed capital receipts from disposal of shares

14.10 10.7.4 Yes

Excluding: s 9C(2A), (3), (4) & (4A)

No


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Reference

to the Income Tax

Act

Topics Reference to SILKE

Reference to notes in TL Examinable

s 22A Schemes of arrangement involving trading stock No

s 22 and 40C

Share dealers Share dealers will be dealt with in TL106, only trading stock related issues are dealt with here

14.11 10.7.5 Yes

s 22B Dividends treated as income on disposal of certain shares

14.11 No

10.5.3 Parts of paragraphs in SILKE which you may ignore The following parts of paragraphs in SILKE may be ignored due to the fact that it deals with sections which are excluded from the syllabus:

Silke reference

Topic

14.8 Contractors’ work in progress (s 22(2A) & s 22(3A))

14.9 Securities lending arrangements and collateral arrangements (s 22(4A), (4B) and (9))

10.6 LAW AMENDMENTS

Law amendments promulgated in the Taxation Laws Amendment Act No. 23 of 2018 (on 17 January 2019).

There were no law amendments applicable to the topics in LU 10.

10.7 NOTES ON TRADING STOCK

10.7.1 Change of intention

Capital asset trading stock

If the intended use of an asset is changed from a capital asset to trading stock, the taxpayer is deemed to have disposed of the asset for CGT purposes. That person is deemed to have disposed of the asset at its market value at that stage for CGT (par 12(1) and 12(2)(c) of the Eighth Schedule). At the same time the taxpayer is deemed to have reacquired the asset as part of trading stock at the same market value. This value will then be deductible as the cost of the trading stock (as part of opening stock - section 22(3)(a)(ii)).

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Illustrative example:

Change of intention from a capital asset to trading stock

If a taxpayer has a capital asset with a cost price of R6 000 and he changes his intention and it becomes part of his trading stock when the market value of the asset is R10 000, it will be a deemed disposal for CGT. The taxpayer will realise a capital gain of R4 000 (R10 000 proceeds less R6 000 base cost). He will be able to claim a deduction for normal tax purposes equal to the market value (deemed to have acquired the asset at current market value) of the trading stock, i.e. R10 000 (as part of opening stock). Refer to the Natal Estates case in TL102.

Trading stock capital assets

If the intended use of an asset changes from trading stock to a capital asset, a deemed disposal of the trading stock for a consideration equal to market value takes place (section 22(8)). The amount will be included in income as a recoupment for normal tax purposes. Since it is now a capital asset, the base cost of the asset for CGT will be the amount (market value) included in the taxpayer’s income for normal tax purposes.

Illustrative example:

Change of intention from trading stock to a capital asset

If a taxpayer purchased trading stock for R6 000 and his intention changed to using it as a capital asset when the market value was R10 000, the taxpayer will have opening stock of R6 000 as a deduction and income of R10 000. The taxpayer will be taxed on R4 000. His base cost for the capital asset will be R10 000 (value included in income – market value). If the taxpayer in future decides to sell the asset for R18 000, he will realise a capital gain of R8 000 (proceeds of R18 000 less base cost of R10 000).

Note that if an asset manufactured by a taxpayer is subsequently used as a capital asset by the taxpayer, it will continue to be regarded as trading stock and there will be no change in use; thus no recoupment under section 22(8) will arise. (Review par (jA) of the gross income definition (SILKE 4.13), as well as the definition of trading stock). Par (jA) includes in gross income any amount received by or accrued to a person in respect of the disposal of any asset manufactured, produced, constructed or assembled by the person, which is similar to any trading stock manufactured, produced, constructed or assembled by that person. For example, par (jA) will be applicable to a car manufacturer that sells cars, but uses some of the cars for its employees as company cars. The receipt or accrual must be included in gross income when the cars are sold, but will remain trading stock until sold (therefore section 22 will apply and the cars will not be treated as capital assets when transferred from stock to company cars, no recoupment will be accounted for). Proviso (d) to section 22(8) ensures that because this trading stock will already be included in income under par (jA) of the gross income definition, it is not also included as a recoupment in terms of section 22(8).

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10.7.2 Trading stock applied for purposes other than trade (section 22(8) and SILKE

par 14.7) Section 22(8) seems to be a problem area for some students and we will therefore deal with it here. The application of the section can be illustrated as follows:

NOTE

1. In our opinion, private or domestic consumption can only pertain to individuals and not companies.

2. If the trading stock is used or consumed in the carrying on of the taxpayer’s trade, the same amount will also be allowed as a deduction as deemed expenditure incurred, apart from a recoupment under this section. If a second-hand car dealer utilises a car from trading stock for deliveries, there will be a recoupment of market value and the market value will then be used to determine the cost of the vehicle to claim a wear-and-tear allowance.

3. Remember that if a manufactured asset is subsequently used as a capital asset, it will continue to be trading stock and there will be no recoupment under this section (see par (jA) of the gross income definition, as well as the definition of trading stock and also the discussion in note 10.7.1 above).

4. In terms of section 23C, cost for purposes of Income Tax will exclude VAT if input tax could be claimed. Therefore, the trading stock will be reflected net of VAT. If trading stock is dealt with in terms of section 22(8), in most cases, a VAT adjustment will have to be made by a VAT vendor in terms of section 18(1) of the VAT Act.

Trading stock? Section 22(8) is not applicable

Utilised as follows:

Private or domestic

consumption (note 1)

Donation Distributed as dividend

in specie

Disposal for less than market value not in the ordinary

course of trade

Used for purpose

other than disposal in

ordinary course of business

(not private or domestic

con-sumption)

Trading stock now

held as capital asset

Are the provisions of section

18A applicable?

No Yes Recoup market value (if sold for less than market value, only the difference between selling price and market value will be recouped).

Recoup amount included in value of stock (cost or written-down value). Only if used for private or domestic consumption and cost cannot be de-termined, use market value.

NO

YES

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10.7.3 Anti-avoidance provisions (s 23F) Three anti-avoidance provisions were introduced into legislation to counter schemes by taxpayers to deduct only the acquisition costs but not include a ‘balancing amount’ in taxable income as closing stock. S23F(1) limits the deduction for acquired stock (under s11(a)) in the following circumstances:

- Trading stock which was neither disposed of (no proceeds included in gross income in terms of sales) by the taxpayer nor held by the taxpayer at the end of the year (no amount is included in taxable income in terms of closing stock (i.e. goods in transit)

The deduction for trading stock acquired will only be allowed in the first year in which:

- Trading stock was disposed of, OR - Value of stock is included in income in closing stock (- s 22(1)), OR - Trading stock was destroyed, OR - Trading stock cannot be disposed of nor held by taxpayer at year-end.

The deduction is limited to the extent that payment has been received for stock disposed of (s 23F(1)). The second and third anti-avoidance provisions (sections 23F(2) and (3)) are excluded from the syllabus.

10.7.4 Deemed capital receipts from the disposal of shares (s 9C)

Read section 9C of the Income Tax Act.

Study par 3.6.21 and par 14.10 in SILKE. Section 9C is included in the SAICA examinable pronouncements, except

subsections 9C(2A), (3), (4) and (4A) which are excluded.

Section 9C was introduced into the Income Tax Act to provide greater clarity on the capital or revenue treatment of share transactions. This section applies to the disposal of equity shares (previously “qualifying shares”) and deems the receipt arising on the disposal to be capital in nature. The equity share must have been held by the taxpayer for a continuous period of at least three years prior to disposal. An “equity share” includes a participatory interest in certain collective investment schemes (including a hedge fund investment scheme) and a hybrid equity instrument as defined in section 8E (section 8E is excluded from your syllabus). The taxpayer need not make an election in this regard; provided such equity shares have been held for at least three years prior to disposal, the proceeds will be capital in nature, even if that person is a share dealer.

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10.7.5 Share dealers We will cover share dealers (SILKE 14.11) in TL106 and we will highlight only the trading stock related issues in this tutorial letter. It is important to understand that if a taxpayer speculates in shares (therefore a share dealer), these shares will be treated as trading stock. Section 22 will therefore be applicable to a share dealer in the same way as to any other taxpayer holding trading stock. There are three exceptions to this general rule:

All financial instruments included in closing stock must be valued at cost, regardless of the nature of the holder (section 22(1)).

Special valuation rules have also been introduced to establish the cost price of any shares held directly by a resident in a controlled foreign company (CFC) (section 22(3)(a)(iii)). THIS DOES NOT FORM PART OF THE SYLLABUS.

If capitalisation shares, any options or any other right to acquire shares in any company are acquired by a share dealer (as part of trading stock) for no value, sections 22(4) and 40C state that these shares, options or rights will have no value.

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10.8 OUTCOMES FOR THE BEANCOUNTER SCENARIO

You have completed LU 10 and should now be able to answer Bizzie Beancounter’s queries. Read through the Beancounter scenario again and make a rough summary of what your solution would be.


a) A recoupment (at cost, R500) is included in taxable income (s22(8)(A))

b) A recoupment (at MV, R750) is included in taxable income (s22(8)(B)) A deduction is allowed (at MV, R750) in terms of s11(a) as it is deemed expenditure under proviso (a) to s 22(8)

c) A recoupment (at cost, R1 000) is included in taxable income (s22(8)(C)) Bizzie will also qualify for a s18A deduction of 10% of her taxable income, limited to the R1 000 donation of trading stock made (s18A(3)(a)(ii))

Table setting out the tax implications of the purchase of trading stock as well as transactions (a) to (c):

(a) (b) (c)

Cost of sales: Purchases (s 11(a) deduction from TI)

(R500)

(R400)

(R1 000)

Recoupment (s 22(8) inclusion in TI) R500 R750 R1 000

Operating expenditure (s 11(a) deduction from TI) (R750)

Effect on taxable income RNil (R400) RNil

This table ignores the s 18A donations deduction Silke example 14.5 adapted


Work through the questions in sections B, C and D of the TL. We recommend that you work through the allocated questions within the allocated time, then use the additional questions provided as revision for tests and exams. This will help you assess your knowledge and revisit any areas that you have difficulty understanding.

END OF SECTION A OF TL 105

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SECTION B: INTEGRATED EXAMPLE

WORK PLAN FOR 31 MARCH 2019 (DAY 5)

Work through the integrated example below. This example will give you an indication at which level you need to apply your knowledge in tests and exams. Please be mindful of your time when working through this example – it should take you between 1 to 2 hours to answer this question and debrief it for yourself (we have allocated 2 hours to this section).

PURPOSE STATEMENT:

SECTION B contains an integrated example and is based on prior year’s examinations and test papers. The objectives of this section are:

to assist you to integrate your knowledge and to apply it, in order for you to answer the questions in self-assessment, tests and exams; and

to give you the opportunity to apply the assessment criteria stated in TL101 in order to prepare for the formative assessments (tests) and the final summative assessment (examination).

After completing the example in the time limit, you should be able to

demonstrate your competency to pass the formative assessments (test) and the summative assessment (exam) relating to the topics you have already covered;

identify areas for improvement in order to rectify them before the tests and examination, for example

- time management problems - shortcomings in your knowledge base - shortcomings in handling data, for example identifying the problem,

distinguishing between relevant and irrelevant information, analysing data, integrating data, evaluating alternatives and the ability to propose practical solutions

- problems with communicating your findings, etc.;

demonstrate your competency to calculate the taxable income of a taxpayer, starting with the accounting net profit (comprehensive income) before tax.

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INTEGRATED EXAMPLE

This integrated example illustrates the application of the topics covered in this tutorial letter as well as the interaction between different topics and different types of taxes (e.g. normal tax, including capital gains tax, and value-added tax. This is a calculation question, however, it could be asked as a discussion question in assessments. Explanatory notes were added in the suggested solution. After reading the question and before attempting it, read the notes on exam technique (the first part of the suggested solution). You will gain the most benefit by attempting the question yourself (as opposed to the “oh-yes method”) before working through the suggested solution.

Macaroni Limited (referred to as Macaroni) is a resident company operating a manufacturing concern in South Africa. Macaroni manufactures Italian food (e.g. pasta, canned olives, pre-cooked meals, desserts, sorbet and ice cream) for exclusive food stores and restaurants (the Commissioner regards this as a process of manufacture). Macaroni is a registered VAT vendor with an April year-end. The company has no majority holder of shares.

The following is the statement of comprehensive income of the company for the financial year ended 30 April 2019:

Notes R R

Revenue 17 098 780

Less: Cost of sales 1 (11 504 500)

Gross profit 5 594 280

Add: Other operating income

Dividends 2 15 500

Rentals 3 80 000

Return from real estate investment trust (REIT) 4 18 400

Profit on sale of patent 5 104 000

Profit on sale of machine B 6 100 000

Profit on sale of delivery vehicle 6 5 000 322 900

Subtotal carried forward 5 917 180

Less: Operating expenses

Depreciation 6 781 800

Interest paid 7 1 984 200

Selling and administration expenses 8 1 139 951

Dividends 9 36 500 (3 942 451)

Net profit (comprehensive income) before tax 1 974 729

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Notes: 1) Macaroni distributed trading stock as a dividend in specie to its holders of shares on 30 April 2019.

The cost price of the trading stock (R40 000) was correctly taken into account in calculating cost of sales. Macaroni’s gross profit mark-up was 50% on cost price.

2) A gross dividend of R15 500 was received on 5 January 2019 from a listed South African company. 3) Machine A - rentals of R20 000

On 1 January 2019, Macaroni purchased machine A from a 25% holder of shares (Noodle Ltd, which has an April year-end) and immediately leased it back to the holder of shares (Noodle Ltd). The holder of shares originally purchased the machine on 1 April 2015 for R600 000 (VAT excluded). Noodle Ltd (the holder of shares) previously used the machine in a process of manufacture and claimed a section 12C allowance in respect of the machine. On the date of the sale of the machine to Macaroni, the machine had a tax value of Rnil. The recoupment for Noodle Ltd on the sale of the machine was R600 000 and 80% of the capital gain on the disposal of the machine amounted to R80 000 (Noodle Ltd had no other capital gains or losses in 2019). After the transaction was concluded (sale and leaseback), the holder of shares continued using the machine in a process of manufacture. Macaroni paid R700 000 (excluding VAT) when it purchased the machine from Noodle Ltd; this was also the current market value on the date of sale. The lease rentals amounted to R5 000 (excluding VAT) per month for the first year and R15 000 (excluding VAT) per month thereafter. Macaroni did not claim depreciation for accounting purposes on this machine. Binding General Ruling No 7 (Interpretation Note No 47) allows for a 5-year write off period. Residential units – rentals of R60 000 Rentals received from the 5 residential units rented out, refer to note 6.9 below.

4) The return from a REIT was received on 30 November 2018 and consisted of interest. 5) On 15 April 2019, Macaroni sold a patent for R1 070 000 (excluding VAT). Macaroni had acquired

this patent from an Italian non-connected company for the equivalent of R1 000 000 (excluding VAT) on 1 November 2018 at which time the expected useful life was estimated at 30 years. The patent was used in the production of income for the period of ownership.

6) Depreciation was calculated on the following assets:

6.1 Patent until 15 April 2019 (refer to note 5)

6.2 Passenger motor car (as defined in the VAT Act) destroyed (refer to note 7.1) 6.3 Machine B and machine E

On 1 September 2017, Macaroni purchased this manufacturing machine B second-hand for cash at a cost of R120 000 from a South African subsidiary (not a VAT vendor) and brought it into use on the same date. The open market value on 1 September 2017 was R150 000, the original cost to the subsidiary was R100 000 (excluding VAT) and the tax value was R60 000 (this machine was sold on 1 April 2019).

On 1 April 2019, Macaroni sold machine B for R140 400 (excluding VAT) to a non-con-nected company. The machine was immediately replaced with a new manufacturing machine (machine E), purchased locally for R160 000 (excluding VAT). Machine E was brought into use on 15 April 2019 and Macaroni elected paragraph 66 of the Eighth Schedule to be applicable.

6.4 Machine C

Macaroni purchased a new manufacturing machine at a cost of R530 000 (excluding VAT) on 1 April 2019. The machine was brought into use on 15 April 2019.

6.5 Office printer

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The printer was purchased and brought into use on 1 August 2018 for R959 (excluding VAT).

6.6 A factory that was erected for R11 856 000 (excluding VAT), completed on 1 January 2012

and brought into use 2 months after completion.

6.7 Improvements of R850 000 (excluding VAT) were effected during July 2016 to the existing factory and brought into use on 15 August 2016.

6.8 Office building

On 1 June 2016, Macaroni commenced with the erection of a new office building. The building was completed and brought into use on 1 November 2018. The total cost of erecting the building amounted to R2 500 000. No depreciation has been accounted for on the office building.

6.9 Residential units

On 1 November 2018, Macaroni purchased 6 flats in a newly erected residential building in the Republic consisting of 12 flats from the developer (a vendor) at a total cost of R200 000 (excluding VAT) each, with the intention of earning rental income. Five of the units were rented out immediately for R2 000 each per month.

6.10 Delivery vehicle Acquired on 15 November 2016 from a non-connected person for R64 000 (excluding VAT). On this date it was envisaged that the delivery vehicle would be used for at least 7 years. The delivery vehicle was brought into use on 30 November 2016. The vehicle was disposed of to a non-connected person on 28 February 2019 for R20 000 (excluding VAT).

The write-off periods in terms of Binding General Ruling No 7 (Interpretation Note No 47) are as follows:

Computer equipment: 3 years Passenger vehicles: 5 years Delivery vehicles: 4 years

7) Interest paid consists of the following:

7.1 Leased motor car (finance lease) 3 600 The motor car originally cost the lessor R59 280 (including VAT). The lease

agreement is for a period of 36 months and was entered into on 1 December 2016. The monthly lease rental is R1 950 (including VAT).

The motor car was irreparably damaged in an accident on 28 February 2019. Macaroni had not insured the motor car and consequently continued to pay the monthly instalments up until year-end as it did not wish to inform the financier of the loss of the asset. Depreciation was provided for up to and including 28 February 2019 (refer to note 6.2).

7.2 Interest on overdraft raised to finance general business expenditure 1 900 000

7.3 Interest on the bond (with Investo Bank) used to finance the purchase of the 6 residential units (refer to note 6.9) 80 000

7.4 Interest on a loan raised to finance payment of dividend 600 Note: all interest has been correctly calculated in terms of s24J where applicable. S24J will be covered in TL106

1 984 200

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8) Selling and administration expenses comprised the following: R Parking fines which the directors considered to be a normal business expense 3 000 Donation to a public benefit organisation (the section 18A prescribed receipt was obtained) 22 000 Sundry tax-deductible expenses 1 114 951

1 139 951

9) An interim dividend of R36 500 was declared and paid on 31 October 2018. 10) Martha Malena (not disabled) and Rosy Lerato (who is disabled) are both in the employ of Macaroni.

On 1 November 2018, these two employees entered into a 6-month registered learnership agreement with Macaroni. Both employees successfully completed the learnership agreement on 30 April 2019. On the date of entering into the agreement Martha held an NQF level 6 qualification and Rosy an NQF level 7 qualification.

REQUIRED:

Calculate the normal tax liability of Macaroni Limited for its 2019 year of assessment starting with the accounting net profit (comprehensive income) before tax of R1 974 729. Show all your calculations and round off to the nearest RAND. Provide brief explanations to support your calcu-lations and clearly indicate (with a brief reason) when no adjustment is required. Assume that Macaroni Limited wants to limit its normal tax liability for the 2019 year of assessment to a minimum.

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Exam technique (how to make the most of information provided in the allowable time): Read the required part After reading the information provided, read the REQUIRED part carefully. At this stage you should be able to identify the following:

Type of question: Long calculation question. Note the verb “calculate”. A statement of comprehensive income with notes is provided. Normally such a question can be answered by starting at the top and working your way down, i.e. tick each item in the statement of comprehensive income and each note as you go along. Be careful not to miss any of the items or notes. Remember that any taxable capital gain is included in taxable income second last, i.e. before the deduction of qualifying donations in terms of section 18A.

Outcome expected: Normal tax liability of Macaroni for the 2019 year of assessment. Until you have calculated this amount, you have in essence not answered the question. This is therefore the equivalent of a conclusion in a discussion question.

Scope of the question: You only have to consider normal tax consequences, which would of course include CGT consequences. Although no reference is made to VAT, you will note as you start working your way through the question that there are a few VAT issues. As you are not instructed to ignore VAT, you have to address the VAT issues evident from the information provided, which will have an effect on the normal tax including CGT of Macaroni for the 2019 year of assessment.

Specific instructions: Note that you are specifically instructed to start with the net profit (comprehensive income) before tax of R1 974 729. A lot of students appear to have diffi-culty with this principle. Apply the following approach when required to calculate taxable income by starting with the net profit (comprehensive income) before tax:

First consider what has already been done for accounting purposes.

Then consider what needs to be taken into account for taxation purposes.

Compare the two approaches.

Make an adjustment (if necessary) if the treatment differs. The adjustment would usual-ly include writing back the accounting entry and including the correct amounts for tax purposes. If you have, for example, an asset on which accounting depreciation was provided for, the depreciation will be added back and instead the wear and tear allowable for tax purposes under the Income Tax Act will be deducted.

Should you find a specific item very confusing, it might be a good idea to reverse whatever was done for accounting purposes and to then consider the tax treatment from “scratch”. Note that you cannot expect to be awarded all the marks if you do not follow the specific instruction (i.e. to start off with R1 974 729). You are also requested to show all calculations, supported by a brief explanation, and to indicate (with a brief reason) where no adjustment is necessary. You therefore have to indicate where the accounting and tax treatments are the same (in line) and no adjustment is necessary. It is best to do your calculations as part of your answer instead of adding calculations to your answer by way of notes. The question states that Macaroni attempts to limit its normal tax liability where possible. This implies that where the Income Tax Act provides for an election (e.g. in the case of section 11(o)), the taxpayer will exercise its option in such a way as to reduce or limit its taxable income where possible.

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Time allocation: It is always important, before you start a question, to establish the time you have available to answer it and of course to adhere to that limit. In the case of a long calculation question, only the total mark is usually indicated. This question could easily count 40 to 50 marks. In a question, which consists of different short parts, the number of marks allocated to different parts can indicate how much detail should be provided in your answer. However, in a long calculation question this is not the case.

Analyse and interpret the information given Remember that excess information is seldom provided. As you start working through the question, you must be able to identify the following:

Macaroni is a resident company and thus taxed on a worldwide basis. Should the question be silent on whether the company is a resident or non-resident, the default would be to assume that the company is indeed a resident company.

You have to first consider (and indicate that you have in fact considered) whether Maca-roni is a small business corporation (SBC). The gross income does not exceed R20m, however, shares are not only held by individuals (Noodle Ltd holds 25%) therefore Macaroni is not a SBC and will pay normal tax at a rate of 28%.

Macaroni carries on a process of manufacture. Remember that section 12C has prefe-rence over section 11(e).

Always double check whether the VAT consequences can be ignored. Look out for information such as whether the company is a vendor or not, whether amounts include or exclude VAT. In this question you have not been told to ignore VAT. Each note indicates whether amounts include or exclude VAT.

Be mindful of possible connected person transactions. You are told in the first paragraph that Macaroni has no majority holder of shares. However, any other company holding at least 20% of the equity shares or voting rights in Macaroni will be a connected person to it.

Start answering the question now

You can now start working through the question from the top. Tick off amounts and notes as you go along. Remember that you have to read, think and then write. Ensure that you answer the question asked, namely what the amount of the normal tax payable by Macaroni is for its 2019 year of assessment.

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EXAMPLE - SUGGESTED SOLUTION

R

Net profit (comprehensive income) before tax 1 974 729 1. Dividend in specie (R40 000 x 150% = R60 000) (s 22(8)(B) - recoupment) 60 000 2. Dividend received – exempt (s 10(1)(k)) (15 500)

3. Lease rentals – machine A:

R5 000 x 4 months (Jan – Apr) = R20 000 taxable in terms of gross income definition; already included in net income (comprehensive income) before tax – no adjustment necessary. Section 11(e) Wear-and-tear on machine A: This is a sale and leaseback agreement and therefore section 23D will limit the allowances claimable by Macaroni (the lessor). Although the lessee, Noodle Ltd (25% holder of shares), will be using the machine in a process of manufacture, section 12C is not available to Macaroni, as Noodle Ltd is not using the machine for the first time (in order for s 12C to apply asset must be brought into use for the first time). Section 11(e) must therefore be used. In terms of section 23D, the section 11(e) allowance must be based on:

-

The lesser of the amount paid by Macaroni to purchase Machine A OR

R700 000

The sum of: The cost or adjustable cost to the connected person (Noodle Ltd)

Less all deductions allowed and deemed to be allowed in terms of section 12C; and

R 600 000 (R600 000)

Plus any amount contemplated in paragraph (n) of the definition of “gross income” in section 1 that is required to be included in the income of the connected person that arises as a result of the disposal – (the recoupment); and

R 600 000

Plus the applicable percentage (80%) of the capital gain (R100 000) (i.e. the taxable capital gain) of the connected person that arises as a result of the disposal.

R80 000

Section 23D limitation R680 000

Thus s 11(e) R680 000/5 years x 4/12 months = R45 333, (Limited to rental income of R20 000 in terms of section 23A, but s 23A excluded from the syllabus)

(45 333)

Rentals from residential units – fully taxable -

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4. REIT

The full amount is a dividend and in terms of section 10(1)(k)(i)(aa) not exempt. The full amount is therefore taxable. No adjustment needed.

-

R 5. Profit on sale of patent for accounting purposes reversed (104 000)

Note that, for VAT purposes, the acquisition of the patent by Macaroni from the Italian non-connected company does not constitute “goods”, but a service. However, it does not constitute “imported services” as defined in section 1 of the VAT Act, as the patent was not used for the purposes of non-taxable supplies. It follows that no VAT was payable by Macaroni on the importation of the patent.

Tax deduction: as the patent was used by Macaroni in the production of income, a deduction can be claimed in terms of section 11(gC). S 11(gC) deduction: R1 000 000 x 5% (no apportionment) = R50 000 Tax value on date of sale thus R1 000 000 – R50 000 = R950 000 Recoupment (s 8(4)(a)): Proceeds of R1 070 000 less R950 000 (tax value) = R120 000 Limited to allowances claimed of R50 000 [OR Proceeds limited to cost R1 000 000 – R950 000 (TV)] CGT effect Proceeds = R1 070 000 - R50 000 (s 8(4)(a) recoupment) = R1 020 000 Base cost = R1 000 000 - R50 000 (s 11(gC)) = R950 000 Capital gain = R1 020 000 – R950 000 = R70 000 (The capital gain on the patent will be aggregated with other capital gains or losses before the donations deduction at the end of the calculation.)

(50 000)

50 000

6. Depreciation: add back 781 800 Tax treatment:

- Patent: deduction in terms of s 11(gC)see point 5 above

- Passenger motor car (leased asset – finance lease is treated as an operating lease for income tax purposes, therefore the lessee is not the owner of the asset and cannot claim capital allowances) – no wear-and-tear as lease payments are claimed under section 11(a): see point 7 below

- Machine E acquired R160 000 x 40% (s 12C – new machine accelerated allowance)

- Machine B: Second-hand machine S 12C applicable S 12C calculated on cost, which is the lesser of actual cost and market value, Macaroni purchased Machine B from a non-vendor and would have been entitled to claim a notional input tax deduction based on the lesser of cost price (R120 000) or open market value (R150 000). Thus R120 000 x 14/114 = R14 737 [the 14/114 tax fraction was applied as the purchase was made prior to 1 April 2018 when the VAT rate was 14%].

-

-

(64 000)

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Macaroni’s cost thus: R120 000 – R14 737 (notional input tax claimed) = R105 263 (s 23C) x 20% (s 12C second-hand machine; no apportionment) = Tax value on date of sale (used below): (R105 263 – R21 053 (2018) – R21 053 (2019) = R63 157)

- Machine B disposed of: Deduct – Accounting profit on sale

Tax value on date of sale R63 157 Selling price = R140 400 S 8(4) recoupment = selling price less tax value – but recoupment limited to allowances claimed Thus R140 400 – R63 157 = R77 243 – limited to R42 106 (R21 053 + R21 053)

[OR Sellling price R140 400 limited to cost R105 263 less R63 157 (tax value)] The asset was replaced, the company can elect par 66. The question specifically states that par 66 of the Eighth Schedule was elected.

R

(21 053)

(100 000)

Therefore, section 8(4)(e) applies and the recoupment will thus be deferred. Recoupment – R42 106 x 40% (allowance claimed for Machine E) (allocation of recoupment based on wear-and-tear claimed on replacement machine in relation to total cost of replacement machine) CGT effect – Machine B Proceeds: R R Received 140 400 Less: Recoupment (s 8(4)) (42 106) 98 294 Less: Base cost Cost (R150 000 (mv par 38*) Iess R14 737 (VATactually claimed)) (135 263) Less: S 12C allowances (2018 +2019) (42 106) (93 157) Capital gain 5 137 x 40% as replaced by “depreciable asset” (par 66(4)) 2 055 * Note: Market value is used because machine B was acquired from a connected person, therefore proceeds for the connected person for CGT purposes is the market value (par 38) and base cost for the purchaser is the market value (par 38). (In terms of par 66, 80% of the capital gain on Machine B will be aggregated with other capital gains or losses before the donations deduction at the end of the calculation.)

- Machine C: New R530 000 x 40% (s 12C – new and unused) =

- Computer printer: less than R7 000 non-manufacturing asset, thus write off to R1 [R959 – R1] (s 11(e) together with Binding General Ruling No 7 (or Interpretation Note No 47))

- Factory (s 13(1)) R11 856 000 x 5%

- Improvements: factory (s 13(1)) R850 000 x 5%

- Office building R2 500 000 x 5% = R125 000 (s 13quin)

- Residential units rented: Since the 5 units qualify as low-cost residential units as defined in section 1

16 842

(212 000)

(958)

(592 800)

(42 500)

(125 000)

63 TAX4862/105

- the units’ cost does not exceed R350 000 (including VAT) each (R200 000 x

1.15% = R230 000) (include VAT since used for exempt supply of residential accommodation (s 12(c) of the VAT Act)); and

- rentals of ≤ 1% of cost are charged (R230 000 x 1%), thus ≤ R2 300 (R2 000 charged per unit); and

- Macaroni owns at least 5 units in the Republic - Therefore section 13sex is applicable, but at 10% (5% plus 5% (as low-cost

residential units) on 55% of the cost as only part of a residential building was acquired [6 of 12 units] (s 13sex(8)): (R230 000 x 55% x 5 units) x 10%

R

(63 250)

- Delivery vehicle: (s 11(e)) R

Cost price 64 000 2017 year (R64 000/4 years x 5/12 months) (6 667) 2018 year (R64 000/4 years x 12/12 months) (16 000) 2019 year (R64 000/4 years x 10/12 months) (13 333) Tax value on date of sale 28 000

Deduct accounting profit on sale of delivery vehicle Selling price: R20 000. As the delivery vehicle’s expected useful life for tax purposes did not exceed 10 years on date of acquisition, it was not acquired from a connected person and the tax value exceeds the proceeds, Macaroni can elect to claim a section 11(o) allowance as follows: Selling price – Tax value = R20 000 – R28 000 (tax value on date of sale) = CGT effect [CGT should always be calculated when an asset is disposed of or

deemed to be disposed of even if it is obvious that there is no capital gain or loss] Note that there will be no CGT effect in respect of the disposal. Proceeds = R20 000 Base cost: Cost less s 11(e) claimed less s 11(o) allowance = R64 000 – R6 667 – R16 000 – R13 333 – R8 000 = R20 000

Thus: R20 000 – R20 000 = 0 capital gain/(loss)

(13 333)

(5 000)

(8 000)

7. Interest paid/lease payments

- Motor vehicle: finance lease - claim lease payments for tax purposes, thus reverse accounting treatment

Lease payments: s 11(a) R1 950 x 10 months - March and April 2019 not in production of income (no s 23C adjustment as no input tax could be deducted for lease payments (acquisition) as it is a motor car as defined in the VAT Act)

Interest paid on overdraft to finance business expenditure; deductible in terms of 11(a), no adjustment required

3 600

(19 500)

-

- Interest paid on the bond to finance the residential units is deductible in terms of s 24J, no adjustment required

- Interest on the loan to finance dividends is not deductible as it is not in the production of income

-

600

64 TAX4862/105

8. Selling and administration expenses

- Parking fines – s 23(o) specifically prohibits such a deduction

- Donation to PBO (see below – the order is important as it must be the last deduction)

- Sundry tax-deductible expenses (deductible s 11(a))

3 000

22 000

- 9. Dividend paid (add back) 36 500 10. Learnership allowance – s 12H

Martha – commencement allowance (s 12H(2)(b)) – R40 000 x 6/12 (20 000) Rosy (disability) – commencement allowance (s 12H(5)) – (R50 000) x 6/12 (25 000) Martha – completion allowance (s 12H(3)) (40 000) Rosy (disability)– completion allowance (s 12H(5))(R50 000) (50 000)

PLUS: Taxable capital gain Point 5 above – sale of patent Point 6 above – Machine B par 66 of the Eighth Schedule

70 000 2 055

Point 6 above – delivery vehicle -

Aggregate capital gain @ Inclusion rate of 80% x R72 055

72 055 57 644

SUBTOTAL 1 389 488

LESS: Qualifying donations (s 18A): R22 000 (point 8 above) Maximum deduction: 10% x R1 389 488 = R138 949 Limited to actual donation R22 000

(22 000)

Indicate to the marker that you know that this is the very last deduction and that it is limited to 10% of taxable income before this deduction. Should you run out of time, make an assumption that taxable income after the inclusion of the taxable capital gain is, for example, R1 000 000, and apply the 10% to this amount to illustrate the application of section 18A.

TAXABLE INCOME 1 367 488

Tax liability @ 28% 382 897

It is important that you indicate the tax rate. By applying 28% you indicate that you know that Macaroni is not a small business corporation (SBC), an employment company or a South African branch of a foreign company.

END OF SECTION B OF TL 105

65 TAX4862/105

¶

SECTION C: SELF-ASSESSMENT ASSIGNMENT

WORK PLAN FOR 31 MARCH, 01 & 02 April 2019 (DAY 5 - 7)

PURPOSE STATEMENT:

In SECTION C, you will find the self-assessment assignment, for you to mark yourself. Use the questions to assess your own knowledge, competencies and take responsibility for your own learning experience.

Nine (9) hours have been allocated to work through Section C. However, for your benefit we provide you with more than 9 hours of questions.

After completing the questions in the self-assessment assignment within the time limits provided you should be able to:

Identify if you have rectified the shortcomings identified in the previous sections;

Demonstrate that you are competent to pass the formative assessments and summative assessment relating to the topics you have covered so far.

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SUMMARY OF QUESTIONS

Question AQSAT / provided

TOPIC Marks / Time

1

1.3 (Part 1 only)

Advice question - comparing the cash flow of a finance lease and a suspensive sale agreement. Sections 8(5)(b), 11(a), 11(e), 12C and VAT Assume the following: - The company has a 28/29 February year-end. - The lease in Option 1 will commence on

1 March 2019. - The finance lease payments include VAT.

15/23

2 1.2 Sections 8(4)(a), 8(5), 11(e), 12C and 23A Assume that the R120 000 mentioned in part A includes VAT. Ignore the information in the question relating to s 23A.

23/35

3 Provided Loan between connected parties, sections 19 and 56 and paragraphs 12A and 56(2) of the Eighth Schedule

25/38

4 Provided Sections 8(4), 8(5), 11(a), 11(cA), 11(gC), 11(e), 11(i), 11(j), 12C, 12H, 23F, 23H, 24I, VAT and CGT.

52/78

5 Provided Company Income Tax calculation (sections 8(4)(e), 11(i), 11(j), 12C, 13sex, 18A, 22(8), 23D and CGT) and discussion on the deductibility of compensation and legal fees

36/54

6 Provided Sections 1 (gross income paragraph (jA), 11(a), 11(o), 12C, 12H, 22(2), 24C and 24M.

24/36

7 Provided Sections 8(4)(e), 11(a), 11(c), 11(gB), 11(m), 11(o), 12E, 12H, 13(1), 13quin, 22(8), CGT and donations tax

42/63

8

Provided Section 1 (gross income paragraph (jA)), sections 8(4)(a), 11(a), 11(d), 11(e), 11(o), 19, 22(1), 22(2) and 22(8) and par 12A of 8th Schedule

31/47

9 Provided Sections 11(a) and 22 and VAT

5/8

10 Provided Debt benefit due to concession or compromise Section 8(4)(a) and 19 6/9

11 Provided Capital allowances and recoupments (specific emphasis on immovable property), leases, learnership agreements and specific deductions Section 11(a), 11(f), 11(g), 12C, 12H, 12N, 13, 24I and CGT

30/45

12 Provided Section 9C 10/15

13 AQSAT General deduction formula 36/54

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Question AQSAT / provided

TOPIC Marks / Time

16.8

14 AQSAT 16.9

General deduction formula 26/39

Total marks / time

357 marks (538 hours)

Additional questions

15 Provided Sections 8(4)(a), 11(e), 11(g),11A, 12C, 12N, 13(1), 13(3), 13quin, 13sex, 23H, 24J and CGT and VAT

50/75

16 Provided VAT, CGT, provisional tax, section 1 (gross income definition, par (jA)) and sections 8(4)(a), 8(4)(e), 8(5), 11(a), 11(cA), 11(gB), 11(d),11(e), 11(j), 11(m), 12C,13(1), 13quin, 19, 23(g), 23B, 23H and 24I

67/101

*AQSAT refers to your prescribed textbook ADVANCED QUESTIONS ON SA TAX 2019.

Please note: Please note that the sections in italics (covering sections 24I, 24J, 25D, 31 and 41), will only be covered in TL106. You therefore do not need to study these sections for the purposes of Test 2.

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QUESTIONS PROVIDED AND SUGGESTED SOLUTIONS

QUESTION 1 (AQSAT 1.3) – Suggested solution 15 marks

Manufacturing Ltd

R R

(1) Option 1

1/3/2019 - 28/2/2024

Lease payments (R2 700 x 60 - R19 500 (claim VAT in full at

beginning of lease))

(162 000) (1)

2024

S 8(5)(b) recoupment - Market value 60 000 (1) No VAT adjustment on transfer at the termination of a lease.

Recoupment is limited to previous lease payments of R2 700 x 60mth (R162 000 less VAT of R19 500) = R142 500

60 000

60 000

(1)

From 1 March 2024 for 6 years

Wear & tear (s 11(e)) – (R60 000/6) = R10 000 for 6 years

(10 000) (1) (Not brought into use for the first time, therefore cannot deduct in terms of s 12C)

Cash effect

Cash outflow - lease payments

(142 500) (1) Tax saving of lease payments s11(a) – R142 500 x 28%

50 820 (1)

Tax saving (s 11(e)) – R60 000 x 28% [R10 000 x 6]

16 800 (1) Tax effect of recoupment – R60 000 x 28%

(16 800) (1)

Total cash outflow

(91 680)

Option 2

Cash cost

130 000

Add: VAT

19 500

149 500 (1)

Less: Payments (R30 000 (deposit) + (R2 300 x 60))

(168 000) (1) Finance charges

(18 500)

Tax savings

2019 – 2024 S 12C fully deducted (40%, 20%, 20%, 20%)

(130 000) (1) Finance charges

(18 500) (1)

(148 500)

Tax @ 28%

41 580 (1)

Cash effect

Cash outflow - payments - (R168 000 (payments) - R19 500 (input tax claimed))

(148 500)

Tax saving (R148 500 x 28%)

41 580

Total cash outflow

(106 920) (1)

Option 1 would be the better option having total cash outflows of R91 680 compared to R106 920 for option 2.

(1)

15

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QUESTION 2 (AQSAT 1.2) – Suggested solution 23 marks

R R

PART A - Elt (Pty) Ltd

(1) Sale machine A

Wear and tear (s 12C)

R730 000 x 20% - (year 2)

(146 000)

(1)

Recoupment Proceeds R850 000 x 100/115 = R739 130

(s 8(4)(a)) limited to cost 730 000

(1) Less: Tax value R730 000 - R438 000

(R292 000 (R730 000 x 40% (2018)) + R146 000 (R730 000 x 20% (2019))

(292 000)

No deferment as no “replacement” 438 000 438 000 (2)

CGT Proceeds R739 130 - R438 000

(recoupment) 301 130

(1)

Less: Base cost R730 000 - R438 000 (allowances) ( 292 000)

(1)

Capital gain

9 130

Taxable capital gain – R9 130 x 80% 7 304 (1)

R

Lease machine A

Input tax R860 000 x 15/115 112 174

Lease payments

25 585

(1)

Less: VAT (s 23C) - R112 174 x 1/48 (2 337)

(1) S 11(a)

23 248 x 3 mths (69 744) (1)

10

(2) Elt would include a recoupment (limited to the deductions for the rental) in gross

income of the market value (R104 348, that is R120 000 x 100/115) of the asset less consideration, therefore R104 348 – R100 000 being R4 348 (s 8(5)(b)).

(2)

No VAT will be payable as it is in terms of the lease agreement and VAT has already been paid.

(1)

Elt will be entitled to a wear-and-tear allowance on the asset acquired in terms of s 11(e) only. Machine A was not brought-into-use for the first time by Elt, therefore s 12C cannot be used. The s 11(e) allowance will be claimed on the market value of R104 348.

(1)

(1) 5

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QUESTION 2 – Suggested solution (continued) PART B – Ranieri (Pty) Ltd

R

R

Land and warehouse rentals

300 000 (½)

Operating leases

2 000 100 (½) Finance leases

850 000 (½)

Rates – land

(122 000) (1) Administration expenses

(640 000) (½)

Salaries and wages

(560 000) (½) Wear and tear - operating leases

(320 000) (½)

S 12C allowance on finance lease assets

R1 500 000 x 20%

300 000

(1)

R960 000 x 20%

192 000

(1) R820 000 x 20% (40% not available to rental

businesses) (proviso (c) to section 12C(1))

164 000

(1)

656 000

(656 000) (1)

Taxable income

852 100

8

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QUESTION 3 25 marks LEX Ltd is a company that is incorporated in South Africa and is listed on the JSE. LEX Ltd holds all of the issued share capital of RK (Pty) Ltd (referred to as RK) and of ART (Pty) Ltd (referred to as ART) and has done so since the dates of incorporation. LEX, ART and RT are a group of companies as defined in section 41 of the Income Tax Act. All three companies are incorporated in South Africa as well as effectively managed in South Africa and are regarded as residents for South African taxation purposes. The companies are all involved in the motor manufacturing industry. The three companies all have a February financial year-end and the pro forma statement of financial position (balance sheets) of RK and ART for the financial year ended 28 February 2019 are summarised below:

ART (PTY) LTD STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 2019

Note R million ASSETS Non-current assets

5 500

Borrowings (loan) due from fellow subsidiary Property, plant and equipment

1 0 5 500

Current assets

6 650

Trade receivables Inventories Cash

2 500 1 750 2 400

Total assets 12 150

EQUITY AND LIABILITIES Equity attributable to owners

7 305

Share capital Retained revenue

1 100 6 205

Current liabilities Trade payables

4 845

Total equity and liabilities 12 150

Note: 1. The loan amounts to R125 million and comprises a capital element of R100 million and accrued

interest of R25 million. The loan has been impaired as a result of the financial position of RK. The impairment led the company to claim the R25 million as a bad debt deduction in terms of section 11(i) of the Income Tax Act in its year of assessment ended 28 February 2019.

72 TAX4862/105

QUESTION 3 (continued)

The loan was originally advanced during the financial year ended 28 February 2016 and was funded out of surplus cash.

RK (PTY) LTD STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 2019

Note R million ASSETS Non-current assets Property, plant and equipment

400

Current assets

910

Trade receivables Inventories

375 535

Total assets 1 310

EQUITY AND LIABILITIES Equity attributable to owners

125

Share capital Retained deficit Borrowings (loan) from fellow subsidiary

1 2

100 (100)

125

Current liabilities

1 185

Trade payables Bank overdraft

1 025 160

Total equity and liabilities 1 310

Notes: 1. The company is in an assessed loss position for the year of assessment ended 28 February 2019

and is expected to have accumulated an assessed loss amounting to R55 million at the end of the year of assessment ending 29 February 2020.

2. RK used the funds received from ART to fund the acquisition of land and buildings utilised for

purposes of its trade. Tax allowances have not been claimed on the buildings so acquired, as they do not qualify for allowances in terms of the Income Tax Act. The R25 million interest expenditure incurred on the loan has, however, been claimed as a deduction in terms of section 24J of the Income Tax Act.

The financial director of LEX Ltd has proposed that ART waive its right to recover the R125 million loan due from RK. He envisages that the transaction should be concluded in April 2019. The purpose of the transaction would be to strengthen the balance sheet of RK (Pty) Ltd as the company is experiencing severe cash flow problems.

73 TAX4862/105


REQUIRED Marks

Discuss, with full supporting reasons and reference to relevant provisions of the Income Tax Act, the potential taxation consequences arising from the proposed transaction from the perspectives of both ART (Pty) Ltd and RK (Pty) Ltd. Assume the following: - The income tax legislation for the 2020 year of assessment will remain the same as

legislation applicable to the 2019 year of assessment. - The waiver of debt is not a scheme to avoid tax.

NOTE: Your solution should deal with any consequences of the proposal, with regard to normal tax (including capital gains tax (CGT)) and donations tax.

25

(QE 2005 paper 1, question 2 - adapted)

74 TAX4862/105

QUESTION 3 - Suggested solution ART (PTY) LTD TO WAIVE ITS RIGHT TO RECOVER THE R125 MILLION LOAN DUE FROM RK (PTY) LTD Implications for RK (Pty) Ltd General

The debt benefit received by RK does not form part of the general definition of gross income as it constitutes an amount of a capital nature.

The waiver of the debt is not part of a scheme to avoid tax.

(1) (1)

Recoupment provisions

Section 19 of the Income Tax Act applies where o a debt benefit in respect of debt owed by a person o arises due to a concession or compromise regarding that debt, and o the amount of the debt was used, either directly or indirectly, to fund any expenditure for

which a deduction or allowance was granted in terms of the Act (section 19(2)).

Section 19 does not, however, apply to a debt reduction that is a bequest, a donation in respect of which donations tax is payable, a taxable employer-employee fringe benefit or specific debt between group companies (where the debtor company is dormant) (section 19(8)). o RK, LEX and ART are a group of companies in terms of section 41 (LEX holds all the

shares of RK and ART). (The requirements of section 41 will be covered in TL106, refer to note below)

o Based on the statement of financial position it is evident that RK was not dormant as it carried on a trade in the previous year of assessment.

No allowance or deduction was allowed for the R100 million loan since it was not used, either directly or indirectly, to fund any expenditure for which a deduction or allowance was granted in terms of the Act and therefore section 19 will not apply and no recoupment will arise on the loan.

The interest expense of R25 million was claimed as a deduction in terms of the Act, however the definition of debt in terms of section 19, excludes interest. Therefore, the provisions of section 19 do not apply to the interest amount. The amount of the reduction will however be recouped in the 2020 year of assessment in terms of section 8(4)(a) (not section 19) in the income of RK.

(1)

(1)

(1)

(1)

(2)

(2)

CGT consequences

The waiver of the loan account will be treated as a disposal for CGT purposes in terms of paragraph 12A of the Eighth Schedule to the Income Tax Act.

In terms of paragraph 12A(6)(d) the provisions of paragraph 12A(2) will apply where the person and the creditor form part of the same group of companies as defined in section 41 and the debtor (RK) is not a dormant company. Therefore in this case, as RK was not dormant the provisions paragraph 12A(2) will NOT apply. o None of the exclusions in terms of paragraph 12A(6)(d) apply.

The provisions of paragraph 12A further do not apply to the extent that the debt benefit (reduced or discharged) was used to fund expenditure in respect of which a deduction or allowance was claimed. o The provisions of paragraph 12A would therefore not apply to the R25 million interest

expenditure (as was claimed in terms of s 24J) already recouped in terms of section 8(4)(a) of the Income Tax Act.

The provisions of paragraph 12A would therefore apply to the R100 million capital portion of the loan waived, because RK is not a dormant company in the group of companies.

(1)

(1)

(1)

(1)

(1)

(1)

75 TAX4862/105

QUESTION 3 - Suggested solution (continued)

There is thus a reduction of the base cost of the asset. That is R100 million (Base cost of land and buildings) – R100 million (debt benefit).

(1)

Implications for ART (Pty) Ltd General

The company has already claimed the interest portion of the debt, i.e. R25 million, as a bad debt deduction in terms of section 11(i) of the Income Tax Act and therefore cannot claim this amount as a deduction again.

With regard to the potential claim of the R100 million capital portion as a deduction for Income Tax purposes, the company would not be able to claim the amount as a deduction in terms of section 11(i) as the amount was not previously included in the company’s income.

The company would not be able to claim the amount as a deduction in terms of section 11(a) of the Income Tax Act either, as the company is not engaged in the trade of money lending. In other words, the loss would be capital in nature and would not be permissible as a deduction.

(1)

(1)

(1)

CGT consequences

The granting of the loan itself is a capital transaction and creates a capital asset for ART (Pty) Ltd with a base cost of R100 million.

From a CGT perspective, the waiver of the loan would be treated as a deemed disposal in terms of paragraph 11(1)(b) of the Eighth Schedule. The proceeds on the deemed disposal amount to Rnil.

ART would suffer a capital loss of R100 million (Rnil – R100 million) which may be deductible for CGT purposes. However, paragraph 56(1) [debt owed by a connected person] of the Eighth Schedule to the Income Tax Act provides that where a creditor disposes of a claim owed by a debtor, who is a connected person in relation to that creditor, that creditor must disregard any capital loss determined as a result of that disposal.

From an analysis of the facts, it is evident that ART and RK are subsidiaries of LEX Ltd. This would mean that ART and RK are connected persons (as defined in section 1 of the Income Tax Act) in relation to LEX Ltd and that LEX Ltd is a connected person in relation to both subsidiary companies. In addition, as both ART and RK are subsidiaries of the same holding company, they would be regarded as connected persons in relation to one another.

(1)

(1)

(1)

In applying the principles to the facts, it would appear that, as ART and RK are connected parties in relation to one another and, based on the provisions contained in paragraph 56(1) of the Eighth Schedule to the Income Tax Act, the capital loss must be disregarded by ART.

However, paragraph 56(2) of the Eighth Schedule to the Income Tax Act states that paragraph 56(1) does not apply to the extent that

RK reduced the base cost of the asset (land and buildings) under par 12A, or

the aggregate capital loss was reduced by virtue of par 12A of the Eighth Schedule.

In this case RK reduced the base cost of the land and buildings and therefore ART would be able to claim the R100 million as a capital loss for CGT purposes.

(1)

(1)

(1)

76 TAX4862/105


Paragraph 56(2)(c) states that paragraph 56(1) [disregards loss] will not apply if RK has to include the R100 million write-off in gross income or to reduce base cost. As RK will reduce the base cost by the R100 million, paragraph 56(2)(c) is applicable. Therefore paragraph 56(1) will NOT apply and ART will NOT disregard the capital loss.

(1)

Donations tax consequences

A further aspect that needs to be considered is a potential donations tax liability, because the disposal by ART of the right to claim payment from RK might constitute a gratuitous disposal.

However, as ART and RK form part of the same group of companies as defined in section 1 of the Income Tax Act, and they are both resident companies, section 56(1)(r) of the Income Tax Act would exempt the transaction from donations tax.

The debt was also waived for commercial reasons for the benefit of the group, therefore it was not a gratuitous disposal.

Therefore, there are no donations tax implications for RK.

(1)

(1)

(1)

(1)

Total 31

Max 25

Note: A group of companies definition is provided in section 41 and this will be covered in TL106. Therefore for the purposes of this tutorial letter the question will explicitly state that the companies are a group of companies in terms of section 41.

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QUESTION 4 52 marks Kiddies Cards (Pty) Ltd (referred to as Kiddies) is a company resident in South Africa. It designs and manufactures cards that are collected by children and sells these cards to producers of breakfast cereals and snack foods. Its financial year ends on the last day of February each year. The issued ordinary share capital of Kiddies was held as follows throughout the 2019 financial year: 40% by Yugi Yuglyo, a resident of Armenia, a country with which South Africa does not have a double

tax agreement 30% by Jessy Ash, a resident of South Africa 20% by Tyson James, a resident of South Africa 10% by Max Pokemon, a resident of South Africa These four holders of shares were also the sole directors of Kiddies during the 2019 financial year. Jessy Ash is its managing director. Jessy Ash, Tyson James and Max Pokemon are all full-time employees and executive directors of Kiddies and as such they receive salaries from the company. Yugi Yuglyo is a non-executive director. All four directors also earn fees for attending directors’ meetings. The meetings are held in South Africa. Directors’ salaries and fees are included in the amount stated under the heading “Salaries, wages and benefits” in the detailed draft statement of comprehensive income. (Note that all amounts reflected in the detailed draft statement of comprehensive income below and in the notes that follow on it exclude VAT where appropriate unless specifically stated to the contrary. Kiddies is a registered VAT vendor, making 100% taxable supplies.) The detailed draft statement of comprehensive income of Kiddies for the year ended 28 February 2019 is as follows: Notes R R Sales Less: Cost of sales Opening stock Purchases

1

(1 525 000) (11 575 000)

16 250 000 (12 500 000)

Less: Closing stock

1

(13 100 000) 600 000

Gross profit 3 750 000 Add: Sundry income

Dividend income Capital profit on sale of local shares Insurance settlement received Prescribed debt Profit on sale of machine A

2 3 4 5

11

29 000 80 000 27 360 6 000 67 500

209 860

3 959 860 Less: Expenditure

Bad debt Increase in provision for doubtful debt Depreciation on motor vehicle Depreciation on computer Finance charges Depreciation on machine A Depreciation on machine B Depreciation on other machinery and depreciable assets Rentals Insurance premiums Salaries, wages and benefits Restraint of trade

6 7 8 9

10 11 11

12 13 14 15 16

(45 000) (6 000)

(37 050) (5 700) (2 200)

(12 500) (18 750)

(86 250) (67 500) (81 000)

(2 900 000) (336 000)

(3 809 860)

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QUESTION 4 (continued) Provision for leave pay Interest Cost of trademark written off Other tax-deductible administrative and marketing expenses

17 18 19

(9 500)

(117 000) (40 000)

(45 410)

Comprehensive income (net profit) before tax 150 000

Additional notes 1. On 1 February 2019, Kiddies concluded a contract to import raw materials from an American supplier

at a cost of $24,000. The raw materials were shipped free on board on 22 February 2019 but had not arrived in South Africa by 28 February 2019. Being concerned with the fluctuation of the exchange rate, Kiddies took out a 2-month forward exchange contract on 1 February 2019 to cover the settlement of the creditor. The creditor is to be settled on 31 March 2019. Kiddies did not, in its 2019 financial year, process any accounting entries relating to any of these transactions. Ruling rates of exchange were as follows:

Date Spot rate Market-related forward rate Period 1 February 2019 $1 = R9,70 2 months 22 February 2019 $1 = R9,55 28 February 2019 $1 = R9,60 $1 = R9,75 1 month 31 March 2019 $1 = R9,65 The average exchange rate for the year ended 28 February 2019 was $1 = R9,50 Forex (s24I) will be covered in TL106. The only information in note 1 that is relevant is that the expense for the stock has been incurred, however, the stock has not been disposed of nor is it held at year-end.

2. The following dividends accrued to Kiddies during the 2019 year of assessment:

Dividends from resident companies operating in South Africa that accrued to Kiddies during the period March 2018 to December 2018. The holding of shares by Kiddies in these companies is less than 50% in all cases.

R

20 200

A distribution from a collective investment scheme in property. This distribution comprises interest of R8 800.

8 800

Total 29 000

3. During the 2019 year of assessment Kiddies disposed of only the following capital assets:

some of its share investments at a capital profit of R55 000 (as determined in accordance with the Eighth Schedule to the Income Tax Act); the related accounting profit is R80 000, and

sale (trade-in) on 31 August 2018 of machine A (see note 11) 4. A road freight contractor had collected an order of cards (trading stock) from Kiddies’ premises for

delivery to a customer. On the way the road freight contractor’s delivery van, along with Kiddies’ trading stock, was stolen. On 15 February 2019 Kiddies received an insurance settlement from its insurer of R27 360 for the stolen trading stock. This amount does not take into account any possible VAT adjustment that may have to be made. Assume that no accounting entry was made to record the sale of the trading stock or the write-off thereof as a result of the theft.

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QUESTION 4 (continued) 5. During the 2016 year of assessment Kiddies had purchased raw materials for R15 000, excluding

VAT, from a manufacturer that was closing down. Kiddies paid R9 000 (being 60% of the purchase consideration) on the date of delivery. For the following 3 years it tried unsuccessfully to pay the 40% balance of the purchase consideration (R6 000). Every cheque posted was returned with “address no longer valid” endorsed on it. Because the debt has now prescribed, the amount owing has been written back in its detailed draft statement of comprehensive income.

6. Bad debt written off of R45 000 consist of R18 000 for trade debtors and a loan of R27 000 to a

supplier who has been liquidated. This loan came about during the 2018 financial year of Kiddies, when it lent R27 000 to a raw material supplier who was experiencing liquidity problems. The supplier was liquidated on 1 December 2018 and Kiddies has been unable to recover any portion of the loan.

7. Kiddies does not apply IFRS 9. Kiddies debtors age analysis as at 28 February 2019:

Debtors Age Current 30 days 60 days 120+ days

Amount R20 000 R33 000 R10 000 R25 000

In the prior year the Commissioner for SARS allowed a doubtful debt allowance in terms of section 11(j) of the Income Tax Act equal to 25% of the year-end accounting provision. The prior year provision for doubtful debt amounted to R44 000. As at 28 February 2019 the provision for doubtful debt was R50 000, an increase of R6 000 from the balance as at 28 February 2018.

8. On 1 June 2018 a motor car used by Kiddies’ sales staff for visits to customers was purchased and

immediately brought into use. (This motor car meets the definition of a “motor car” provided in section 1 of the VAT Act.) It cost R299 000 (R260 000 plus VAT of R39 000). Depreciation of R37 050 has been provided for on this motor car. SARS’ Binding General Ruling No 7 (or Interpretation Note No 47) provides for a five-year (5) write-off period for motor vehicles.

9. On 1 December 2016 Kiddies leased a computer from a financial institution under a 2-year finance lease. Kiddies capitalised the financial lease for accounting purposes. It is treated as an instalment credit agreement for VAT purposes. The computer cost the financial institution R19 665 (R17 100 plus VAT of R2 565). Total finance charges in terms of the lease amounted to R4 506 and the monthly rental to R1 000. The final lease rental of R1 000 was paid on 30 November 2018. On 1 December 2018 the financial institution simply abandoned this computer to Kiddies without requi-ring any further consideration by Kiddies. Ownership was therefore attained on 1 December 2018. On this date its fair market value was R11 500 (R10 000 plus VAT of R1 500). Despite being 2 years old, the computer was still in good working order and Kiddies indeed used it during the entire 2019 year of assessment. Depreciation of R5 700 has been provided for on the computer. SARS’ Binding General Ruling No 7 (or Interpretation Note No 47) provides for a 3-year write-off period for computers.

10. The finance charges of R2 200 accounted for in the 2019 statement of comprehensive income concern the finance lease for the computer in note 9.

11. On 1 March 2017 Kiddies purchased a new machine (machine A) on a cash basis in an arm’s length

transaction for R100 000. Machine A was immediately brought into use in its process of manufacture. On 31 August 2018 it traded this machine in for a more advanced manufacturing machine (machine B). Machine B was purchased as a new machine on a cash basis in an arm’s length transaction for R150 000. A trade-in price of R130 000 was obtained for machine A. On that date machine A had a book value of R62 500. Machine B was immediately brought into use in its process of manufacture. Kiddies will elect any option that is available to it to defer any of its tax liability.

12. All other machinery and depreciable assets had a Rnil tax value on 1 March 2018.

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QUESTION 4 (continued) 13. The rentals are paid monthly for the use of a warehouse leased by Kiddies for trade purposes. 14. Insurance premiums of R81 000 were incurred during the 2019 year of assessment. In addition, Kiddies

paid insurance premiums of R88 750 covering the period 1 March 2019 to 29 February 2020 on 15 February 2019, on the advice of its insurance broker who claimed that this early payment would secure cheaper insurance. No portion of the advance insurance premium amount was expensed to its statement of comprehensive income for the 2019 financial year.

15. Salaries, wages and benefits of R2 900 000 include directors’ salaries and fees. On 1 August 2018

Kiddies employed a learner (who is not disabled and holds a NQF level 5 qualification) on a full-time basis at a wage of R750 per week. (This learner was not previously employed by Kiddies.) Kiddies entered into a four month, registered learnership agreement with the learner in the course of its trade. The agreement commenced on 1 October 2018 and was completed on 31 January 2019. The learnership agreement is registered with the relevant sector education and training authority (SETA). Kiddies has complied with all the requirements of the Skills Development Act. The wages paid to the learner and the levies paid to the relevant SETA are included in the salaries, wages and benefits.

16. The restraint of trade payment of R336 000 was paid to a designer who had been employed by

Kiddies. She left its employ on 30 September 2018. The restraint of trade agreement is effective for 2 years commencing on 1 October 2018. The amount of the restraint of trade payment will be included in the gross income of the designer.

17. The leave pay provision was increased by R9 500 for the 2018 financial year. As at 28 February 2019

the balance on the leave pay provision amounted to R54 500. Actual leave payments made during the year have been expensed directly to salaries, wages and benefits.

18. Interest incurred during the 2019 financial year on the company’s business bank account (overdraft)

amounted to R117 000. 19. On 1 December 2018 Kiddies purchased outright the “Beyblade” trademark from another card

manufacturer for R40 000. The acquisition gives Kiddies the exclusive right to market cards under the Beyblade trademark in South Africa.

20. In January 2018 Kiddies bought stock for R24 150 (R21 000 plus VAT of R3 150) from a local supplier. Kiddies claimed an input tax credit of R3 150 for its tax period 1 December 2017 to 31 January 2018. However, because of quality problems, Kiddies paid the supplier only R19 320 (R16 800 plus VAT of R2 520) on 31 January 2018, refusing to settle the account until the quality problems had been resolved. On 28 February 2019 an amount of R4 830 (R4 200 plus VAT of R630) was still outstanding despite numerous letters of demand from the supplier. The amount was reflected under creditors in the statement of financial position of Kiddies as at 28 February 2019. No VAT adjustment that may be required has been reflected in the detailed draft statement of comprehensive income of Kiddies for the 2019 financial year. None of this stock was on hand as at 28 February 2019.

Additional information

Kiddies has neither an assessed loss nor an assessed capital loss to carry forward from its 2018 year of assessment.

REQUIRED Marks

Calculate the normal tax liability of Kiddies Cards (Pty) Ltd for its 2019 year of assess-ment. Show all workings and address all items. Your answer should start with the com-prehensive income (net profit) before tax of R150 000. You can assume that Kiddies Cards (Pty) Ltd is not a small business corporation.

52

(QE 2005 paper 2, question 2)

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QUESTION 4 - Suggested solution R

1. Net profit before tax 150 000

S 23F, expense incurred but stock imported not disposed of nor held at year-end; therefore, no deduction allowed

-

(1)

Ignore, s24I will be covered in TL106 Unrealised s 24I loss on foreign creditor, $24,000 x (R9,60 – R9,55) (1 200) (1) Unrealised s 24I gain on FEC, $24,000 x (R9,75 – R9,70) 1 200 (1)

2. Local dividends, exempt (% shareholding is irrelevant) (s 10(1)(k))

Interest distribution from collective investment scheme (CIS) in property, no exemption

(20 200)

-

(1)

(1)

3. Deduct accounting capital profit on sale of local shares (see point 22) (80 000) (1)

4. VAT adjustment on insurance award; deemed supply, output VAT should be raised, and removed from amount for normal tax purposes, R27 360 x 15/115 No adjustment for loss - not included in closing stock or turnover

(3 569)

-

(1) (1)

5. Recoupment of prescribed debt in terms of s 8(4)(a) read with s 19 Already included in taxable income; no adjustment required

-

(1)

6. Bad debt, trade debtors, deductible in terms of s 11(i), no adjustment required Bad debt, loan to supplier, never included in taxable income, not a moneylender, not deductible, add back

-

27 000

(1) (Refer to capital gains calculation at the end, point 22)

7. Add back increase in accounting provision for doubtful debts, not deductible S 11(j), 2018 provision for doubtful debt, add back previous year allowance, 25% x R44 000 S 11(j) deduction, as Kiddies does not apply IFRS 9 The doubtful debt allowance is the sum of – - 40% of debt in arrears for 120 days or more [R25 000 x 40% = R10 000],

plus

- 25% of debt in arrears for 60 days or more (excluding debt to which IFRS 9 applies or that is already included in the 40%) [R10 000 x 25% = R2 500].

(R10 000 + R2 500)

6 000 11 000

(12 500)

(1) (1)

(1)

(1)

8. Add back depreciation on motor vehicle S 11(e), wear and tear on motor car, R299 000 x 1/5 x 9/12 months (VAT is included in the R299 000, as the input tax deduction was denied in terms of s 17(2) of the VAT Act.)

37 050 (44 850)

(1) (1)

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QUESTION 4 - Suggested solution (continued) R

9. Add back depreciation on computer (NB: s 11(e) is not applicable as the asset is not owned while under lease!) Lease rentals on computer - deductible as it is a finance lease Cost excluding VAT R17 100 Finance charges R 4 506 R21 606 ÷ 24 months = R900,25 p.m. for 9 months (excluding VAT) [1 March 2018 to

30 November 2018] as it is an “instalment credit agreement” (the total VAT amount (R2 565) was claimed at the beginning of the lease)

S 8(5)(bA) recoupment on abandoned computer Original cost to lessor R17 100 Less: 20% diminishing (R 3 420) R13 680 Less: 20% diminishing (R 2 736) R10 944 Limited to market value of R10 000 Limited to the total rentals deducted of R21 606 S 11(e), wear and tear on computer, R10 000/1 (1 year of write-off period remains) x 3/12 (as the company now owns it!)

5 700

(8 102)

10 000

(2 500)

(1)

(1)

(1) (1)

(1)

(1) (1)

(1) 10. Add back accounting finance charges on the lease of the computer equipment,

as full lease payment can be claimed, refer to note 9 (above)

2 200

(1)

11. Deduct accounting profit on sale of machine A Add back depreciation on machine A S 12C allowance on machine A, R100 000 x 20% Add back depreciation on machine B S 12C allowance on machine B, R150 000 x 40% S 8(4)(a) recoupment on sale of machine A Selling price R100 000 Less: Tax value (R 40 000) (R100 000 - (R40k + R20k)) Recoupment R 60 000 Recoupment limited to allowances previously claimed, R60 000. Par 66 of the Eighth Schedule is applicable as proceeds exceed base cost (refer to calculation of capital gains at the end of the question), and therefore the recoupment is deferred in terms of s 8(4)(e), based on the allowance granted on the new machine B, therefore R60 000 x 40% (R60 000/R150 000) = R24 000

(67 500) 12 500

(20 000) 18 750

(60 000)

24 000

(1) (1) (1) (1) (1)

(1)

(1)

12. Add back depreciation on other machinery and depreciable assets 86 250 (1)

13. Rentals, deductible under s 11(a), no adjustment required - (1)

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QUESTION 4 - Suggested solution (continued) R 14. Insurance premiums for the 2019 year of assessment, deductible under

s 11(a) This is a prepayment in terms of s 23H, as no benefit was received during 2019 year of assessment, period of prepaid benefits > 6 months (proviso (aa) to s 23H), but since the prepaid amount is less than R100 000, the amount is fully deductible (proviso (bb) to s 23H) [Note that no information of any other prepayments was provided in the question].

-

(88 750)

(1)

(1)

15. Salaries, wages, benefits, directors’ fees, deductible under s 11(a), no adjustment required Learnership allowance, s 12H(2)(a)(ii),

Commencement allowance: R40 000 x 4/12 (s 12H(2)(b)

Completion allowance: R40 000 (< 24 months) (s 12H(3))

-

(13 333) (40 000)

(1) (1)

16. Add back restraint of trade payment, capital in nature S 11(cA) deduction, lesser of

one-third, R336 000/3 = R112 000 or

amount divided by number of years, R336 000/2 = R168 000

336 000

(112 000)

(1)

(1) (1)

17. Add back increase in leave pay provision, not deductible (s 23(e)) 9 500 (1)

18. Interest deductible under s 11(a) not s 24J (TL106) as an overdraft is payable on demand and therefore falls out of the scope of s 24J.

- (1)

19. Add back deduction of trademark, capital in nature No s 11(gC) allowance available for the acquisition of trade marks

40 000 -

(1) (1)

20. Cost of VAT adjustment for purchases not paid for within 12 months (s 22(3)(b) of the VAT Act)

(630)

(1)

Other tax-deductible administrative and marketing expenses -

21. 22.

Taxable capital gain (see notes 3 and 11 above): Capital gains on disposal of local shares (given) R55 000 Capital gain on disposal of machine A (R30 000 x 40%) R12 000

Proceeds Selling price R130 000 Less: Recoupment (s 8(4)(e)) (R 60 000) R 70 000

Base cost Cost price R100 000 Less: Allowances (s 12C) (R 60 000) (R 40 000) Capital gain R 30 000 Par 66 applicable as proceeds > base cost, therefore inclusion based on allowances granted on the new machine, current year, 40% = *R60 000/R150 000)

(1)

(1)

(1)

(1)

23. Capital loss - loan to supplier (Proceeds - R0; base cost = R27 000)

(R27 000) Net capital gain R40 000 Inclusion rate of 80%

32 000

(1)

(1)

TAXABLE INCOME 234 016

Taxed at 28% 65 524 (1)

Total 53

Max 52

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QUESTION 5 36 marks This question consists of two related parts. Yum-Yum Babyfood Limited (referred to as Yum-Yum) is a resident company that manufactures organic baby food (classified as a process of manufacture by SARS) that is sold both locally and internationally. Yum-Yum has a June year-end and a 1-month tax (VAT) period. Yum-Yum is not a small business corporation and has no majority holder of shares. PART A 28 marks Solly, the accountant of Yum-Yum, has done a preliminary tax calculation for the company for the year of assessment ending 30 June 2019 and determined a taxable income of R37 250 000. Since Solly was uncertain as to the correct tax treatment of the following items, these items have not yet been included in the taxable income of R37 250 000. All amounts exclude VAT unless specifically stated otherwise. 1. Trading stock (cost of sales have been included correctly in the calculation of the taxable

income of R37 250 000, except for the cost of the imported berries in point 1.3, which has not yet been included in the cost of sales)

1.1 On 1 August 2018 Yum-Yum donated non-perishable baby food to the Help a Child Foundation,

a qualifying public benefit organisation, and received a section 18A receipt. The cost of the stock donated was R15 000 and the company has a mark-up percentage of 150% on cost on all the products it sells.

1.2 Yum-Yum launched a new Yum-berry range of baby desserts during September 2018. For the

month of September, every customer buying a tin of Yum-Yum baby food received a tin of Yum-berry dessert as a free gift. As a result, stock, with a cost of R75 000, was given to customers as promotional gifts (marketing).

1.3 Yum-Yum imports organically grown berries for its Yum-berry range from the United States of

America. Yum-Yum ordered berries, at a cost of $20,000 on 31 March 2019. The berries were shipped free on board (FOB) on 15 April 2019 and were delivered at Yum-Yum’s premises on 15 May 2019. Import duties of R5 780 were payable on the importation. A forward exchange contract (FEC) for a 3-month period at a forward rate of R9,75 was entered into on 1 May 2019 to serve as a hedge against the debt. The debt was settled on 31 July 2019. 70% of the imported berries were still on hand at year-end.

The following exchange rates are applicable:

Date Spot rate

$1 = R

31 March 2019 $1 = R9,80

15 April 2019 $1 = R9,85

01 May 2019 $1 = R9,83

15 May 2019 $1 = R9,70

30 June 2019 $1 = R9,60 FEC rate: $1 = R9,65

(market related for a 1-month period)

31 July 2019 $1 = R9,95

Average exchange rate for 2019 year of assessment

$1 = R9,80

Forex (s 24I) will be covered in TL106

85 TAX4862/105

QUESTION 5 (continued) 2. Fixed assets

On 1 December 2018, Yum-Yum bought 7 newly built flats in a residential building consisting of 12 flats, directly from a developer (a registered vendor), for R350 000 each (excluding VAT). All of these residential units were rented out to employees of Yum-Yum, effective from 1 January 2019, for R3 500 each per month.

On 1 January 2019, Yum-Yum sold one of its manufacturing machines, machine A, to a non-connected company for R2 750 000. The machine (when purchased new on 31 March 2017) had an original cost of R2 700 000 and tax allowances of R1 620 000 have been claimed until 30 June 2018 in terms of s 12C.

Machine A was immediately replaced by Machine B, which was purchased from Organic Baby Drinks Limited, a subsidiary of Yum-Yum, for R3 500 000 when the market value was R3 250 000. The machine was originally purchased by Organic Baby Drinks Limited for R3 000 000 and tax allowances of R2 400 000 had been claimed by Organic Baby Drinks Limited on the machine until the date of sale. Machine B will also be used by Yum-Yum in its process of manufacturing.

On 31 March 2019, Yum-Yum bought Machine C from Veggies Limited, a non-connected company, for R1 575 000 and then leased it back to Veggies Limited from 1 April 2019 for R45 000 per month. The machine was originally purchased by Veggies Limited on 1 April 2017, for R1 600 000, and tax allowances of R640 000 in terms of s 11(e) have been claimed on the machine until the date of sale. Binding General Ruling No 7 (or Interpretation Note No 47) allows for a write-off period of 5 years on similar machines. The remaining useful life of the machine was 3 years on the date of sale to Yum-Yum.

3. Doubtful debt and bad debt

21. Yum-Yum does not apply IFRS 9. In the 2018 year of assessment, the Commissioner allowed 25%

of the doubtful debt provision of R60 000 for tax purposes. The provision was increased by R20 000 for the 2019 year of assessment. Yum-Yum’s debtors age analysis as at 30 June 2019:

Debtors Age Current 30 days 60 days 120+ days

Amount R50 000 R45 000 R40 000 R25 000

Bad debt of R65 000 were written off during 2019. Of this amount o R40 000 relates to trade debtors being written off; o R25 000 relates to the outstanding debt of an existing employee, of which R20 000 relates to

the capital loan amount and R5 000 relates to the outstanding interest on the capital amount.

86 TAX4862/105

QUESTION 5 (continued) PART A

REQUIRED Marks

Calculate the normal tax liability of Yum-Yum Babyfood Limited (“Yum-Yum”) for the year of assessment ending 30 June 2019. Assume that Yum-Yum wants to minimise its normal tax liability for the 2019 year of assessment and will use any provision of the Income Tax Act available to achieve this and that current legislation will stay in force for the whole of the 2019 year of assessment. Show all your workings. Indicate, with reasons, if an amount has no tax implications and round off all amounts to the nearest rand.

28

PART B 8 marks Contrary to the results of all the previous research performed by Yum-Yum, one of Yum-Yum’s customers (a 6-month-old baby) developed an allergic reaction to their organic butternut baby food. The baby had to be hospitalised on 15 July 2019 and Yum-Yum paid, in terms of a court settlement, the hospital bills amounting to R35 000, as well as the family’s legal expenses of R5 000.

REQUIRED Marks

Discuss, with reference to case law and legislation, whether the R40 000 will be deductible in the hands of Yum-Yum for tax purposes.

Bonus marks will be awarded for relevant cases.

8

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QUESTION 5 – Suggested solution PART A 28 marks R Taxable income 37 250 000 1.

Trading stock - Donation

- Yum-berry promotion

Recoupment at cost in terms of s 22(8)(C) – donation in terms of s 18A (allowable deduction – see s 18A later) No adjustment, as applied for purposes of trade (marketing) no recoupment under s 22(8)

15 000

-

(1)

(1)

Berries imported – s 24I

Cost of sales (s 11(a)): ($20,000 x R9,85 (s 25D)) + R5 780 Foreign exchange differences (s 24I) Debt: $20,000 x (R9,85 – R9,60) - gain FEC: $20,000 x (R9,75 – R9,65) – loss Closing stock (s 22(1)) (R202 780 x 70%)

(202 780)

5 000

(2 000) 141 946

(2)

(2)

(2) (1)


2. Fixed assets

Residential units – s 13sex

Rentals received: R3 500 x 7 units x 6 months S 13sex allowance: R350 000 x 1.15 (include VAT as exempt supply and no VAT claimable – s 12(1)(c) of the VAT Act) = R402 500 R399 000 x 7 units x 5% x 55%

Note: These are not low-cost residential units as the cost of each flat exceeds R350 000.

147 000

(76 808)

(1)

(1) (1)

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QUESTION 5 – Suggested solution (continued) 3.

- Machines A

and B – ss 12C, 8(4)(e) and par 66 of Eighth Schedule

R Machine A: Purchase price = 2 700 000 Less: Wear and tear (s 12C): Previous – given (1 620 000) 20% x R2 700 000 (2019) (540 000) Tax value 540 000 Less: Selling price limited to cost R2 700 000 R2 160 000 But can elect par 66 of the Eighth Schedule as proceeds are equal to or greater than base cost (see below) and defer recoupment in terms of s 8(4)(e)

R

(540 000)

(1)

(1)

(1)

Capital gains tax implications R Proceeds 590 000 (R2 750 000 – recoupment of R2 160 000) Less: Base cost (540 000) (R2 700 000 – s 12C of R2 160 000) 50 000 The capital gain can be deferred as per discussion above (see end of calculation) Machine B Section 12C(2) - Cost calculated as the lesser of actual cost (R3 500 000) or cash transaction at arm’s length (R3 250 000) in terms of s 12C(2), thus although paid R3 500 000, use R3 250 000 R3 250 000 x 20% (second-hand machine: s 12C) Therefore: S 8(4)(e) recoupment on machine A [roll-over]: R2 160 000 x 20% (same % as machine B)

(650 000)

432 000

(1)

(1)

(1)

(1)

(1)

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QUESTION 5 – Suggested solution (continued) 4. Sale and

leaseback – s 23D

Cost calculated in terms of s 23D(2A): Original cost for Veggies R1 600 000 Less: Allowances claimed (R 640 000) Add: Recoupment R 615 000

Cost R1 575 000 Less: Tax value (R 960 000) (R1 600 000 – R640 000))

Add: Taxable capital gain R nil Capital gain

Proceeds R1 575 000 less: recoupment (R 615 000) = R 960 000 Base cost R1 600 000 less: allowances (R 640 000) = (R960 000) Capital gain = Rnil Cost ito s23D(2A) R1 575 000 thus equal to amount paid

R1 575 000/3 years x 3/12 (s 11(e)) Rentals received: R45 000 x 3 months

R

(bonus)

(131 250)

135 000

(2)

(2)

(1)

5. Doubtful debt (s 11(j))

Add back R60 000 x 25% = R15 000 (2018) (s 11(j)) As Yum-Yum does not apply IFRS 9, the doubtful debt allowance for 2019 is the sum of –

40% of debt in arrears for 120 days or more [R25 000 x 40% = R10 000], plus

25% of debt in arrears for 60 days or more (excluding debt to which IFRS 9 applies or that is already included in the 40%) [R40 000 x 25% = R10 000].

(R10 000 + R10 000)

15 000

(20 000)

(1)

(1)

5. Bad debt (s 11(i)) Trade debtors – deductible Loan – not included in gross income, thus capital loan amount is not deductible. The amount related to the interest is deductible as it was included in gross income

(40 000)

(5 000)

(1)

(1)

36 473 108 Capital gain/loss

calculation R Capital gain on machine A (point 2 above) But par 66 of Eighth Schedule applicable, thus R50 000 x 20% included (based on machine B) 10 000 Net capital gain and inclusion (@ 80%) taxable income or the of 2019 year of assessment (10 000)

8 000

(1)

Subtotal 36 481 108 6. Donation

(s 18A) R15 000 (see point 1 above), but maximum deduction: 10% of R36 481 108 = R3 648 111, but limited to R15 000

(15 000)

(1)


Tax liability

@ 28%

10 210 510

(1)

Total 32

Max 28

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QUESTION 5 – Suggested solution (continued) PART B 8 marks

The compensation paid of R35 000 will only be deductible if all the requirements of section 11(a) are met. The compensation must be an expenditure or loss, actually incurred, during the year of assess-ment, in the production of income and not of a capital nature. Furthermore, it must be laid out for the purposes of trade (section 23(g)). (2)

All of the requirements are met, except for “in the production of income” and “not of a capital nature”, which need to be discussed further.

To determine whether the compensation paid was in the production of income, two questions must be asked:

What action gave rise to the expenditure? The production and sale of baby food gave rise to the expenditure. (1)

Is this action closely connected with the income-earning activities? (Is it a necessary concomitant of the business?) The sale of baby food is closely connected to the income-earning activities. (1)

(Joffe & Co (Pty) Ltd v CIR (1946 AD) and Port Elizabeth Electric Tramway Co Ltd v CIR (1936 CPD)) (1)

The compensation paid was therefore expenditure incurred in the production of income.

In determining whether the expense is capital in nature, you must establish whether it is part of

the cost of performing the income-earning operations (which it is in this case – being related to products sold), or (1)

the cost of establishing, improving or adding to the income-earning structure (New State Areas Ltd v CIR (1946 AD) & BPSA (Pty) Ltd v SARS (2007)) (1)

The compensation is not creating an enduring benefit and is a once-off expense, thus not of a capital nature. (1)

Since the compensation meets all the requirements of section 11(a) read with section 23(g), it will be deductible. (1)

The legal expenses of R5 000 will also be deductible under section 11(c) since it is not of a capital nature (following the nature of the compensation paid) and the compensation to which it relates is deductible under section 11(a) (section 11(c)(ii)). (1)

Total 10 Max 8

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QUESTION 6 24 marks

Meat Made Easy Limited (“MME”) is a resident company that manufactures meat cutting machines (classified as a “process of manufacture” by SARS) used by hunters, farmers and butcheries in South Africa and other African countries. The company also owns a game farm and ten butcheries. MME has a December year-end and a one-month tax period for VAT purposes. MME is not a small business corporation. The equity share capital in MME is held as follows:

60% by Ching Limited, a non-resident company located in Beijing, China;

20% by Chow Limited, a non-resident company located in Hong Kong, China;

20% by various residents of the Republic of South Africa. The following transactions which have an effect on the calculation of MME’s taxable income for the 2019 year of assessment occurred in either the company’s 2018 or 2019 year of assessment. All amounts exclude VAT, where applicable, unless specifically indicated otherwise: 1. On 1 April 2018 MME sold a machine that had been used in the company’s manufacturing process

to Please Eat Meat Limited, which has an April year-end. In terms of the agreement Please Eat Meat Limited had to pay an amount of R180 000 on 1 April 2018 and thereafter 10% of the value of the products produced by the machine during Please Eat Meat Limited’s 2019 year of assessment. Please Eat Meat Limited paid MME R180 000 on 1 April 2018 and R350 000 on 1 April 2019.

MME acquired (and brought into use) the manufacturing machine that was sold to Please Eat Meat Limited on 1 August 2017 as a new machine for R552 000 (including VAT).

2. On 15 November 2018 MME entered into a 9-month learnership agreement with Keba Skosana, a disabled employee who holds a NQF level 7 qualification. The learnership agreement meets all the requirements of section 12H. Keba successfully completed the learnership on 14 August 2019.

3. The cost of manufacturing a meat cutting machine amounted to R12 080 for the 2019 year of assessment and R10 800 for the 2018 year of assessment. MME has a mark-up percentage of 60% on cost on all products sold. On 1 January 2019 MME had 180 machines in stock that were manufactured during the 2018 year of assessment. During the 2019 year of assessment the company manufactured 6 250 meat cutting machines. The company uses the first-in-first-out (FIFO) method when selling stock.

The following movement took place in respect of trading stock during the company’s 2019 year of assessment:

The company sold 5 580 meat cutting machines to customers in South Africa. Sales took place evenly throughout the year of assessment.

On 1 October 2019 MME transferred eight meat cutting machines to be used in the butcheries owned and operated by the company. These machines will eventually be sold by MME as second-hand machines.

4. On 1 December 2019 MME received a non-refundable deposit of R50 000 from Namibia Star

Hunters Limited, a company in Namibia, in terms of a contract for four specialised meat cutting machines. These machines are similar to the current machines manufactured by MME but in terms of the contract need to be adjusted for the fitting of specific electrical motors, chains and blades. The company estimated that the cost of these machines will be R17 250 (including VAT) each. The machines will be sold for R25 000 (excluding VAT) each. Manufacturing of these machines will commence on 1 January 2020. On completion MME will deliver the machines to Namibia Star Hunters Limited in Namibia.

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REQUIRED Marks

(a) Note 1 only: Calculate the amounts to be included or deducted in the calculation of Meat Made Easy Limited’s taxable income in respect of note 1 for the company’s 2018 and 2019 years of assessment. If any amount that you have calculated is not deductible or should not be included in the calculation of the company’s taxable income provide a reason or reference to legislation. You can assume that the company will elect any tax option available to reduce its income tax payable in a specific year of assessment.

10

(b) Note 2 to 5: Calculate the amounts to be included or deducted in the calculation of the taxable income of Meat Made Easy Limited for the company’s 2019 year of assessment in respect of notes 2 to 5. Provide a reason or reference to legislation if any event (note or part of a note) has no effect on the calculation of the company’s taxable income. Assume that the Commissioner will allow the cost as a percentage of contract price as the basis for calculating future costs in respect of contracts, where applicable.

14

TOTAL 24

Unisa 2017 adapted

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QUESTION 6 – Suggested solution Part (a) R R Please Eat Me Limited

1. 2018:

Cost: R552 000 x 100/115 = R480 000

480 000

(1)

Allowances claimed (288 000)

Section 12C (2017) R480 000 x 40% (192 000) (1)

Section 12C (2018) R480 000 x 20% (96 000) (96 000)

(1)

Tax value on 1 April 2018 192 000

Less: Selling price (amount received 1 April 2018) 180 000 (1)

(((

Section 11(o) loss (R180 000 – R192 000 = (R12 000)) – not deductible in terms of section 20B read with section 24M, suspended until full consideration received

(12 000)

(1)

2019: Selling price - received

350 000

(1)

Less: Tax value – fully deducted in 2018 - (1)

350 000 Less: Section 11(o) not claimed in 2018 (12 000) (1)

Recoupment BUT 338 000

Limited to section 12C allowances claimed (R192 000 +R96 000 = R288 000)

288 000 (1)

ALTERNATIVE: Selling price – received (R180 000 + R350 000)

530 000

(2)

Less: Tax value – fully deducted in 2018 (192 000) (1) Recoupment BUT 388 000

Limited to section 12C allowances claimed R192 000+ R96 000 = R288 000)

(1)

Capital Gains

Proceeds (R350 000 + R180 000 – R288 000 (recoupment)) 242 000 (1) Less: Base cost (R480 000 – R288 000 (section 12C allowance claimed))

(192 000)

Capital gain 50 000

Include @ 80% (inclusion rate for companies) 40 000 (1)

Total 15

Max 10

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QUESTION 6 – Suggested solution (continued)

Part (b) Meat Made Easy R R

2. Annual allowance:

(R20 000 + R30 000) x 7/12

(29 167) (2)

Section 12H(2A)(a) & Section12H(5) and apportion in terms of section 12H(2A)(b) only in respect of full months

On completion:

(R20 000 + R30 000) Sections 12H(3) & 12H(5ª) (50 000) (1)

3. Opening stock (180 x R10 800 (section 22(2)) (1 944 000) (1)

Cost of production (6 250 x R12 080) (section 11(a)) (75 500 000) (77 444 000) (1)

Sales (180 x (R10 600 x 160%)) 3 110 400 (1)

((5 580 – 180) x (R12 080 x 160%)) (section 1 - definition of gross income) 104 371 200 107 481 600

(2)

Machines moved to butcheries – no adjustment (definition of gross income, paragraph (jA)) -

(1)

Closing stock ((180 + 6 250) – 5 580) x R12 080) 10 268 000 (2)

4. Income (zero-rated VAT as direct export) 50 000 (1)

Section 24C allowance

(((R17 250 x 100/115) x 4) / (R25 000 x 4)) x R50 000 (30 000) (3)

Total 15

Max 14

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QUESTION 7 42 marks This question consists of two related parts. Megachef (Pty) Ltd (referred to as Megachef), a resident company, manufactures and sells premium stainless steel kitchenware. This is classified as a process of manufacture by SARS. The company has a 30 September year-end and is a registered VAT vendor. All amounts in the question exclude VAT (if applicable), unless specifically stated otherwise. Megachef started 10 years ago as the dream of the happily married couple Mr Salt and Mrs Pepper Chef (who are married out of community of property). The company has, however, grown into a multimillion rand business with a gross income of R12 500 000 and employed 16 full-time employees (including Salt and Pepper) throughout the year of assessment. The shares are held in equal parts by Salt and Pepper, who are also both directors of the company. PART A 25 marks The effect of the following transactions on Megachef’s 2019 year of assessment have not yet been taken into account in the calculation of the taxable income of R8 450 670: 1. The following is a list of Megachef’s fixed assets and transactions relating to the fixed assets not yet

taken into account:

Megachef ordered a new manufacturing machine (machine A) from a supplier in Germany for €350,000 on 15 August 2018. Machine A was shipped free on board (FOB) on 1 September 2018 and was delivered at Megachef’s premises on 25 September 2018. The correct amount of VAT was paid (and claimed as input tax) and import duties of R37 500 were paid on importation. On 1 September 2018, Megachef entered into a 3-month forward exchange contract (FEC) with Independent Bank Limited in order to hedge the full purchase price. The machine was brought into use on 1 October 2018. The full payment for the machine was made to the supplier on 30 November 2018.

The following exchange rates were applicable:

Date Spot rate €1 = R

15 August 2018 €1 = R10,38

1 September 2018 €1 = R10,50 €1 = R10,56 (forward rate under

a 3-month FEC)

25 September 2018 €1 = R10,55

30 September 2018 €1 = R10,30 €1 = R10,60 (forward rate under

a 2-month FEC)

1 October 2018 €1 = R9,95

30 November 2018 €1 = R9,70


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Owing to Megachef’s rapid expansion, the company had to replace one of its mobile cranes (crane A) with a more powerful one (crane B) for the packaging department. Crane A was acquired new for R175 000 from an independent party on 15 June 2017 and immediately brought it into use. On 1 September 2018, crane A was sold for R182 000 to an independent party. Crane B (new and unused) was purchased for R250 000 on the same day to replace crane A and was immediately brought into use. Binding General Ruling No 7 (or Interpretation Note No 47) allows for a 4-year write-off period on these mobile cranes, if applicable.

During the last 6 months of 2015 a factory building and an office block were both erected by Megachef at a cost of R1 500 000 and R650 000, respectively, and were both brought into use on 1 January 2016.

2. During the 2019 year of assessment, an annuity of R5 000 was paid to Mrs Salad Dressing (aged 38), a former employee who was instrumental in helping to set up the business but who decided to be a stay-at-home mom after the birth of her twins during the 2018 year of assessment.

3. On 1 July 2019, Megachef registered a new patent for a newly designed kitchenware range under the Patents Act 57 of 1978 and paid R2 800 for registration fees.

4. On 1 July 2018, Megachef entered into a 12-month learnership agreement with Ice Cream (not

disabled) who holds a NQF level 5 qualification. Ice Cream successfully completed the learnership agreement on 30 June 2019. Ice Cream receives an annual salary of R50 000, which has already been taken into account in the calculation of the company’s taxable income of R8 450 670.

5. Megachef has an assessed capital loss of R1 500 that the company brought forward from the 2018

year of assessment.

REQUIRED Marks

Calculate the normal tax liability of Megachef (Pty) Ltd for its 2019 year of assessment. Start your calculation with the taxable income of R8 450 670. Show all your calculations and round off amounts to the nearest rand. Provide brief explanations to support your calculations and clearly indicate nil effects (with a brief reason). Assume that the company will qualify as a small business corporation and will elect any option available to minimise its tax liability.

25

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QUESTION 7 (continued) PART B 17 marks Megachef (Pty) Ltd is one of the main sponsors of a reality cooking competition running for a 3-month period (15 October 2019 to 15 January 2020). The sponsorship agreement (for which Megachef had to pay its legal advisors R3 500 to draw up) stated the following:

Megachef will supply all the kitchenware required by the contestants during the cooking competition. Ownership of the kitchenware will be retained by Megachef during this period.

Megachef’s logo and contact details will be advertised during and after every televised episode of the show.

All the kitchenware used by the contestants during the competition will be returned to Megachef at the end of the competition, after which it will be donated to the Stellenbosch Children’s Orphanage (not a registered public benefit organisation (PBO)).

On 1 October 2019, kitchenware, with a cost price of R100 000 and a market value (excluding VAT) of R150 000, was made available to the organisers of the competition. On 31 January 2020, after the reality show was recorded, the kitchenware was checked by Salt and Pepper before being donated to the children’s orphanage. They discovered that kitchenware with a cost price of R3 750 (and an original market value (excluding VAT) of R5 625) had disappeared and that kitchenware with a cost price of R2 250 (with an original market value (excluding VAT) of R3 375) had been damaged beyond repair and could not be donated. The damaged kitchenware was sold as scrap metal for R500 to a non-vendor, and this amount was then also donated to the children’s orphanage. The remaining kitchenware, valued at R55 000 (market value (excluding VAT) after being used in the competition), was donated to the children’s orphanage that same afternoon. These were the only donations that Megachef made during the 2020 year of assessment.

REQUIRED Marks

Discuss all the tax implications (except for VAT, which you can ignore) in respect of the sponsorship agreement for Megachef (Pty) Ltd for its 2020 year of assessment. Your discussion should refer to relevant legislation and also to case law (bonus marks will be awarded for relevant case names), where applicable. Substantiate your discussion with calculations. Assume that the tax legislation for the 2020 year of assessment will remain the same as legislation applicable to the 2019 year of assessment. Present your answer under the following headings:

Legal cost

Kitchenware supplied for the competition

Donation of kitchenware to the Stellenbosch Children’s Orphanage

Stock stolen

Stock sold as scrap and proceeds donated

17

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QUESTION 7 - Suggested solution PART A Megachef (Pty) Ltd’s tax liability for the 2019 year of assessment R Taxable income 8 450 670

1 Fixed assets:

Machine A imported – ss 12E and 24I

Purchase price (s 12E(1)) - capital: (€350,000 x R10,50 (s 25D)) + R37 500 = R3 712 500 No s 12E allowance claimed during 2018 as only brought into use on 1 October 2018, thus claim 100% under s 12E(1) in 2019 Foreign exchange differences (s 24I) All foreign exchange differences from 2018 would have been deferred to 2019, since the asset was only brought into use in 2019 (s 24I(7)) Debt: 2018: €350,000 x (R10,50 – R10,30) 2019: €350,000 x (R9,70 – R10,30) FEC: 2018: €350,000 x (R10,60 – R10,56) 2019: €350,000 x (R9,70 – R10,60) Forex (s 24I) will be covered in TL106

(3 712 500)

70 000 210 000

14 000

(315 000)

(2)

(1)

(1½) (1½)

(1½) (1½)

Cranes A and B – ss 12E(1A), 8(4)(e) and par 66 of Eighth Schedule

Crane A: R Purchase price = 175 000 Less: Wear and tear (s 12E(1A)): 2017: R175 000 x 50% (87 500)

2018: R175 000 x 30% (52 500) Tax value 35 000 Less: Selling price of R182 000 limited to cost 175 000 Recoupment (s 8(4)(a)) 140 000 But could elect par 66 of the Eighth Schedule as pro-ceeds are equal to or greater than base cost (see below) in 2018 and defer recoupment in terms of s 8(4)(e)

(2)

(1)

(1)

Capital gains tax implications R Proceeds 42 000 (R182 000 (SP) – recoupment of R140 000) Less: Base cost (35 000) (R175 000 – s 12E(1A) of R140 000) 7 000 (Capital gain can be deferred (refer to discussion above) – see end of calculation for CGT inclusion)

(1)

(1)

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QUESTION 7 - Suggested solution (continued) Crane B: R250 000 x 30% (2nd yr (2019): s 12E(1A)) Therefore: S 8(4)(e) recoupment on crane A: R140 000 x 30% (same % as crane B)

R

(75 000)

42 000

(1)

(1)

Factory building

and office block – ss 13(1) and 13quin

Factory – R1 500 000 x 5% (s 13(1))

Offices – R650 000 x 5% (s 13quin)

(75 000)

(32 500)

(1)

(1)

2 Annuity to former employee – s 11(m)

No deduction as not owing to ill health, old age or infirmity – s 11(m) not applicable

-

(1)

3

Patent registration fee – s 11(gB)

Full registration fee deductible (s 11(gB))

(2 800)

(1)

4

Learnership agreement – s 12H

Annual allowance: R40 000 x 9/12 (s 12H(2)(a)) Completion allowance: R40 000 s 12H(3))

(30 000) (40 000)

(1) (1)

Capital gain/loss calculation

R Capital gain on crane A (point 1 above) But par 66 of Eighth Schedule applicable, thus R7 000 x 30% included (based on crane B) 2 100 Assessed capital loss brought forward from the 2018 year of assessment (1 500) 600 At 80% inclusion rate 480

480

(1)

(1)

(1)


Tax liability = R58 930 + (28% x (R4 504 350 – R550 000)) = R58 930 + R1 107 218

1 166 148

(1)

(Apply SBC table) Total 27

Max 25

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QUESTION 7 - Suggested solution (continued) PART B Tax implications of the sponsorship agreement Legal cost Income tax implications The provisions of section 11(c) will first be applied to the legal cost of R3 500 to establish if it will be deductible under this section (section 23B(3)). Section 11(c) is applicable to legal expenses actually incurred by the taxpayer during the year of assessment in respect of any claim, dispute or action of law arising in the course of or by reason of the ordinary operations undertaken by them in the carrying on of their trade. The finalisation of the sponsorship agreement is not in respect of any claim, dispute or action of law and as such section 11(c) will not be applicable. (1) Section 11(a) will have to be applied: For an amount to be deductible in terms of the general deduction formula, all of the following requirements must be satisfied (i.e. section 11(a) read with section 23(g) of the Income Tax Act): (1)

The taxpayer must carry on a “trade”.

The amount to be claimed must constitute “expenditure or losses”.

The expenditure or loss must be “actually incurred” by the taxpayer during the year of assessment in which it is claimed.

The expenditure or loss must be “incurred in the production of income”.

The expenditure or loss must “not be of a capital nature”.

The expenditure or loss can only be claimed to the extent to which the amount was laid out or expended for the purposes of the taxpayer’s trade. (1)

All of the requirements are met, but “in the production of income” and “not of a capital nature” need to be discussed further. To determine whether the legal cost was in the production of income, two questions should be asked:

What action gave rise to the expenditure? The finalisation of the sponsorship agreement gave rise to the expenditure. (1)

Is this action closely connected with the income-earning activities? (Is it a necessary concomitant of the business?) The sponsorship is closely related to the income-earning activities, since it will lead to advertising, which will inevitably increase sales and will give rise to income in the future. (1)

(Port Elizabeth Electric Tramway Co Ltd case or BP South Africa (Pty) Ltd case) (1)

The legal cost was therefore expenditure incurred in the production of income. (Alternative: the act entailing the expenditure must be a “necessary/inevitable concomitant” of the taxpayer’s trade) (Joffe & Co (Pty) Ltd case) In determining whether the expense is capital in nature, you must establish whether it is part of

the cost of performing the income-earning operations – legal cost will be part of the cost of performing the income-earning operations, or (1)

the cost of establishing, improving or adding to the income-earning structure – it is not creating an enduring benefit and will not be capital in nature.

(New State Areas Ltd case or Rand Mines (Mining & Services) Ltd case) (1)

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QUESTION 7 - Suggested solution (continued) The legal cost paid is part of the cost of performing the income-earning operations and thus not of a capital nature and will be allowed as a deduction under section 11(a). (1) Kitchenware supplied for the competition Income tax implications Trading stock has been used for purposes other than the disposal in the ordinary course of business (section 22(8)(b)(iv)), therefore proviso (d) to section 22(8) will be applicable – the assets supplied represent trading stock manufactured and as such represent assets to which the provisions of paragraph (jA) of the gross income definition in section 1 will be applicable – and no recoupment will be made under the provisions of section 22(8). It will still be treated as part of trading stock. No adjustment for tax purposes. (2) Donation of kitchenware to the Stellenbosch Children’s Orphanage Income tax implications Trading stock has been applied for the purposes of making a donation (s 22(8)(b)(i)) – note that proviso (d) to section 22(8) will no longer be applicable, since it only applies to section 22(8)(b)(iv) – and a recoupment at market value of R55 000 of the kitchenware supplied for the competition will be included in the calculation of the taxable income of Megachef (Pty) Ltd. (Note that cost price is not recouped, since section 18A will not apply to the donation.) (3) No deduction of 10% of taxable income will be allowed under section 18A, since it was not made to a qualifying PBO. (1) Donations tax implications Donations tax at a rate of 20% will be payable on the market value of the donation of kitchenware of R55 000 plus the cash donation of R500, thus R11 100 (R55 500 x 20%) donations tax will be payable at the end of the month following the month during which the donation was made after the date of the donation, thus on or before 29 February 2020. (3) Stock stolen No further adjustment, since the deduction will be allowed when this stock is not included in closing stock. (1) Stock sold as scrap and proceeds donated Income tax implications The R500 received for the sale of the damaged kitchenware should be included in gross income as trading stock sold. (1) The R500 donated will not be allowed under section 18A as a deduction from taxable income of Megachef (Pty) Ltd, since it was not made to a qualifying PBO. (1)

Total 21

Max 17

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QUESTION 8 31 marks This question consists of three (3) unrelated parts (Part A to Part C). You are currently studying towards your Postgraduate Diploma in Applied Accounting Sciences (CTA 2) and are preparing for your final examination. You have begged and borrowed, various test and exam questions from some of your friends studying at other institutions and today, after finalising your studies of Tutorial Letter 105, have decided to attempt some of these questions as part of your final preparation. Assume that all amounts exclude VAT, unless specifically stated otherwise. PART A 13 marks QUESTION FROM UNIVERSITY A Standby Elec (Pty) Ltd (referred to as Standby) is a resident company that specialises in the manufacturing and maintenance of industrial generators. Standby is a VAT vendor that only makes taxable supplies. It has a 31 December year-end and does not qualify as a small business corporation. The write-off period of generators under Binding General Ruling No 7 (or Interpretation Note No 47) is 15 years. On 1 September 2018, Standby took one of its manufactured generators from its trading stock to be used on a temporary basis as a capital asset at its administrative office building. It was Standby’s intention to sell this generator in future. It will be sold as a used or second-hand generator. The cost to manufacture this generator (incurred during its 2018 year of assessment) was R1 250 000. Its market value on 1 September 2018 was R2 050 000. Its market value on 31 December 2018 was R1 750 000.

On 30 August 2019, Standby sold the generator that it had been using in its administrative office building for R1 955 000 (including VAT).

REQUIRED Marks

(1) Calculate (supported with reference to legislation) the effect that the information provided in part A has on the taxable income for Standby Elec (Pty) Ltd in its 2018 and 2019 years of assessment. Assume that the current legislation is applicable to both the 2018 and 2019 years of assessment.

4

(2) Recalculate (supported with reference to legislation) the effect that the information provided in part A has on the taxable income for Standby Elec (Pty) Ltd’s 2018 and 2019 years of assessment, on the assumption that it does NOT manufacture generators, but merely buys and sells them. Round all amounts to the nearest rand.

9

(University of Pretoria – adapted)

PART B 9 marks QUESTION FROM UNIVERSITY B Going-Slow (Pty) Ltd (referred to as Going-Slow), a VAT vendor with a June year-end, is one of many manufacturing companies (this is classified as a process of manufacture by SARS) currently experiencing serious cash flow problems owing to the slow economy. To try and save the business and to regain financial stability, the company has requested a compromise of its debts from several of its creditors.

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QUESTION 8 (continued) The details of two of the transactions (both with independent parties) for which Going-Slow requested and was granted a compromise of its outstanding debt on 30 June 2019 are listed below:

Out-of-Cash Ltd discharged the outstanding debt relating to a new manufacturing machine purchased by Going-Slow on 1 April 2018 for R1 850 000. SARS allows for a 5-year write-off period on these machines (if applicable) in terms of Binding General Ruling No 7 (or Interpretation Note No 47). R950 000 of this debt was still outstanding on 30 June 2019.

An outstanding creditor, Restless (Pty) Ltd, with a balance of R765 000 on 30 June 2019, was discharged. Going-Slow owed Restless (Pty) Ltd this amount for various trading stock purchases made during Going-Slow’s 2019 year of assessment. Going-Slow still had R350 000 of this trading stock on hand at 30 June 2019.

REQUIRED Marks

Discuss, supported by calculations and reference to Income Tax legislation, the normal tax implications of the transactions for Going-Slow (Pty) Ltd for the company’s 2019 year of assessment.

9

PART C 9 marks QUESTION FROM UNIVERSITY D On 15 September 2018 Reno Vate (a 40-year-old female) decided to buy a small house, renovate it and rent it out in order to earn additional income. The purchase price was R1 250 000. Although the property is old, it only required limited work before it could be let. The first tenant moved in on 1 January 2019 (paying a monthly rental of R8 000), after Reno had affected the following renovations: R Replacement of damaged carpets with wooden floors 25 000 Installing a security system 35 000 Painting of the exterior and interior walls of the house 12 500 Landscaping the garden (the house did not have a garden before, only grass) 15 000

Total cost 87 500

REQUIRED Marks

Discuss, with reference to section 11(d) and case law, whether the renovation expenses incurred by Reno Vate will be deductible for income tax purposes during her 2019 year of assessment. Bonus marks will be awarded for relevant case names.

9

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QUESTION 8 – Suggested solution

31 marks

PART A

(1) Normal tax consequences that will arise for Standby Elec (Pty) Ltd in its 2018 and 2019 years of assessment

R

2018 year of assessment

The manufacturing costs (excluding VAT) are deductible under s 11(a) (1 250 000) (1) There is no s 22(8) adjustment (recoupment) because the generator was manufactured by Standby it will be dealt with under par (jA) of the gross income definition on disposal (no capital allowances are allowed as it is not considered to be an allowance asset); thus it is treated as trading stock until sold. -

Closing stock is valued at the lesser of cost or market value (s 22(1)) 1 250 000 (1)


Opening stock (s 22(2)) (1 250 000) (1)

Gross income (s 1 par (jA)) (selling price, excluding VAT)

(R1 955 000 x 100/115) 1 700 000 (1)

4

(2) Normal tax consequences for Standby Elec (Pty) Ltd on assumption that it does NOT manufacture generators, but merely buys and sells them


The acquisition costs (excluding VAT) are deductible under s 11(a) (1 250 000) (1) S 22(8) adjustment (recoupment) at market value 2 050 000 (2)

S 11(e) over 15 years (2 050 000/15 x 4/12) (45 556) (1) Note: Section 11(e) is applied as the information did not state that Standby qualified as a process of manufacture. 2019 year of assessment

S 11(e) over 15 years (2 050 000/15 x 8/12) (91 111) (1)

S 11(o) is NOT applicable since the write-off period exceeds 10 years Tax value [R2 050 000 – R136 667 (R91 111 + R45 556)] = R1 913 333 and selling price is R1 700 000 (R1 955 000 x 100/115) -

(1)

CGT

Proceeds: Selling price is R1 700 000 (excluding VAT) (1) Base cost on date of sale: R2 050 000 – R136 667 (R91 111 + R45 556) = R1 913 333 (1) Standby will thus have a capital loss of R213 333 (R1 700 000 – R1 913 333) that may be deducted from aggregate capital gains or carried forward to the next year of assessment. (1)

Total 9

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QUESTION 8 – Suggested solution (continued) PART B Going-Slow (Pty) Ltd R Manufacturing machine – Out-of-Cash Ltd

The debt benefit arose due to a compromise regarding a debt that was initially used to finance an allowance asset, therefore section 19 applies. The amount of the debt benefit of R950 000 will first be applied to reduce the base cost of the asset of R740 000 (R1 850 000 – R740 000 (40% - 2018 (s 12C)) – R370 000 (20% - 2019)) in terms of par 12A. The base cost of the asset will now be reduced to Rnil (R740 000 – R740 000). No further allowances on the manufacturing machine will be allowed under s 19(7).

(2) (1)

The remaining debt benefit amount of R210 000 (R950 000 – R740 000) will be a recoupment.

(1)

Recoupment under s 19(6) read with s 8(4)(a) is included in gross income

210 000

(1)

Trading stock – Restless (Pty) Ltd

The debt benefit amount of R765 000 will first be applied to reduce the cost of the trading stock still held at the time of the compromise of the debt. The deduction under s 11(a) for the trading stock purchased will be reduced to R415 000.

Purchase of trading stock (s 11(a)) (765 000) (1) Debt benefit due to compromise under s 19(3) 350 000 (1) The remaining amount of R415 000 (R765 000 – R350 000) of the debt

benefit will be a deemed recoupment in gross income under s 19(4) read with s 8(4)(a)

Recoupment (s 19(4) read with s 8(4)(a)) 415 000 (2)

Total 9

PART C The renovation cost will only be deductible if it meets all the requirements of section 11(d), namely that it is

expenditure actually incurred

during the year of assessment

on repairs of property

occupied for the purposes of trade, or in respect of which income is receivable. The expenditure was actually incurred by Reno Vate (given) during the 2019 year of assessment (started on 15 September 2018 and finalised in December 2018, year-end 28 February 2019). (1) The main concern is whether each cost can be classified as a repair. A repair is a renewal of a subsidiary part, whereas an improvement will increase the income-earning capacity of the asset (Flemming v KBI (1994)). (2)

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Replacement of damaged carpets with wooden floors – this is a repair, since it is a renewal of a subsidiary part, although the replacement material is not identical (CIR v African Products Manufacturing Co Ltd (1944)). (2)

Installing a security system – this is not a renewal of a subsidiary part, it is a new addition and an improvement to the house. (1)

Painting of the exterior and interior walls of the house – classified as a repair, since the house is restored to its original condition. (1)

Landscaping of a garden (the house did not have a garden before, only grass) – the garden is a new addition, will increase income-earning capacity – not a repair (not replacing a subsidiary part), but an improvement. (1)

The replacement of the carpets and the painting of the walls might qualify for deduction under section 11(d) but only if they are in respect of an asset in terms of which income is receivable. Although income was not received when the repairs were done, the section only requires that income is receivable at the time of the repairs being done. (1) Conclusion The R25 000 for the floors and the R12 500 for the painting will be deductible under section 11(d), whereas the cost of the garden and the security system will be classified as improvements and would be part of the base cost of the house. (1) Total 10 Max 9

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QUESTION 9 5 marks Five years ago, Mrs Flan, a cordon bleu chef, opened a cookery school. For this purpose, she formed a close corporation, and named it Flan’s Cookery School CC. Mrs Flan is its sole member and one of its employees. Mrs Flan’s member’s interest in Flan’s Cookery School CC is her only shareholding in a company or close corporation. The school is registered as a vendor for value-added tax (VAT) purposes. It has to submit a 2-monthly VAT return for periods ending on the last day of February, April, June, August, October and December of each year. Flan’s Cookery School CC has a February year-end. The school enrols a total of 20 trainees each year. It is closed during the school holidays and therefore operates over 4 terms per year. The trainees are charged a fee of R3 220 per term (which includes VAT of R420). You have recently qualified as a chartered accountant. Mrs Flan has approached you with the following VAT and normal tax queries relating either to herself, or to Flan’s Cookery School CC, or to both of them. Query 1 Flan’s Cookery School CC purchased consumable stores (for example, soap powders, dish clothes, dishwashing liquids, polish, oven cleaners, disinfectants) for its entire 2019 calendar year during January 2019 for R23 000 (R20 000 plus R3 000 VAT). Mrs Flan has taken 5% of these consumables for use in her private home (the cost of the individual items of consumable stores used could not be readily determined). A further 10% was consumed by the cookery school during January and February. At the end of its year of assessment, 85% of the consumable stores were therefore still on hand.

REQUIRED Marks

Explain to Mrs Flan both the normal tax and VAT consequences of using 5% of the consumable stores purchased by Flan’s Cookery School CC in her private home and of 85% of the consumable stores still being on hand at the end of the year of assessment of Flan’s Cookery School CC.

5

(Extract SAICA 2002 adapted)

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QUESTION 9 – Suggested solution Query 1 Normal tax implications for Mrs Flan When Mrs Flan helped herself to the consumable stores, she was given a taxable fringe benefit by her employer (Flan’s Cookery School CC). The value of this fringe benefit is, in terms of paragraph 5(2) of the Seventh Schedule to the Income Tax Act, (1) Fringe benefits will be covered in TL107 “the cost thereof to the employer or, where such asset was held as trading stock and the market value thereof was less than such cost, such market value”. (1) On the assumption that the market value is greater than the cost of the trading stock, the cost of R1 000 (R20 000 x 5%) must be included in Mrs Flan’s gross income. Normal tax implications for Flan’s Cookery School CC Flans’ Cookery School CC will be entitled to a R20 000 deduction in terms of section 11(a) in its 2019 year of assessment for the purchases of the consumable stores. Note that section 23H cannot limit this deduction as it does not apply to the acquisition of trading stock. (1) As the definition of trading stock includes consumable stores, it forms part of Flan’s Cookery School CC’s trading stock. An amount of R17 000 (R20 000 x 85%) will be included in closing stock for the 2019 year of assessment, being the consumable stores on hand at the end of its year of assessment (section 22(1) of the Income Tax Act). (1) The use of the consumables by Mrs Flan falls under section 22(8)(b)(iv), in that it is trading stock that was applied other than in the ordinary course of trade (as the cost could not be readily determined [given in the facts]). Flan’s Cookery School CC will be deemed to have disposed of the trading stock at market value. Therefore 5% of trading stock used by Mrs Flan will be included in Flan’s Cookery School CC’s income as a recoupment at market value in terms of section 22(8)(B). A deduction of the same amount will be allowed as part of salary cost. (1) VAT implications for Flan’s Cookery School CC When Flan’s Cookery School CC purchased the consumable stores, an input tax deduction of R3 000 was claimed. (1) Although Mrs Flan took 5% of these consumable stores for her own use, no adjustment is required in terms of section 18(1) of the VAT Act because the consumable stores are still used in making taxable supplies (providing an employee with a fringe benefit). (1) Flan’s Cookery School CC will, in terms of section 18(3) of the VAT Act, have to account for a deemed output tax for this taxable benefit which it provided to its employee, Mrs Flan, calculated by multiplying the cost of the consumable stores by the tax fraction (15/115). The cost is the consideration which is calculated as the cash equivalent under the Seventh Schedule (being the lower of cost or open market value, which in this case we assume is the cost), i.e. R1 000 (thus R1 000 x 15/115 = R130). (1) No adjustment for the items still on hand at year-end.

Subtotal 8

Max 5

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QUESTION 10 6 Marks Pharma City (Pty) Ltd is a wholesale pharmaceutical supplier with a 31 December year-end. The company is not a small business corporation. On 1 December 2019, Pharma City (Pty) Ltd debt amounted to R700 000. The debt is made up as follows: Creditor 1 Purchase of delivery vehicle (purchased during 2018) R400 000 Creditor 2 Purchase of trading stock (purchased during 2019) R300 000

The company experienced financial difficulties and was unable to pay its outstanding debt. As a result, both creditors discharged the outstanding debt owing by Pharma City (Pty) Ltd on 1 December 2019. On this date, Pharma City (Pty) Ltd had closing stock of R180 000 (all purchased from Creditor 2) and the delivery vehicle had a tax value of R300 000.

REQUIRED MARKS

Discuss, supported by calculations and with reference to Income Tax legislation, the tax implications of the transactions for Pharma City (Pty) Ltd for the company’s 2019 year of assessment.

6

Extract Test 2 2013 adapted

QUESTION 10 – Suggested solution Tax implications of the transactions for Pharma City (Pty) Ltd for the company’s 2019 year of assessment: R Purchase of delivery vehicle (creditor 1) The debt benefit of R400 000 will first be applied to the base cost of the asset (R300 000 (also the tax value)). Reducing the base cost to Rnil. No further allowances on the vehicle will be allowed under section 19(7).

(1) The remaining R100 000 (R300 000 – R400 000) will be a recoupment. (1) Recoupment under section 19(6) read with section 8(4)(a) 100 000 (1) Purchase of trading stock (creditor 2) The debt benefit of R300 000 will first be applied to reduce the cost of the trading stock still on hand at the time of the debt benefit. The deduction under section 11(a) for the trading stock purchased and still on hand at the date of the debt benefit will be reduced to Rnil.

Purchase of trading stock (section 11(a) – initial deduction for stock purchased) (300 000) (1) Debt benefit under section 19(3) 180 000 (1) The remaining R120 000 of the debt benefit will be a deemed recoupment in income under section 8(4)(a) (section 19(4))

Recoupment (section 19(4) read with section 8(4)(a)) 120 000 (1)

6

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QUESTION 11 30 Marks This question consists of two related parts (A and B). Etophia (Pty) Ltd (Etophia) is a South African company that manufactures leather suitcases and handbags. The company has a December year-end and is a vendor for value-added tax (VAT) purposes with monthly tax periods. All amounts exclude VAT, unless specifically stated otherwise. The information under Parts A and B relates to the 2019 year of assessment of Etophia (Pty) Ltd: PART A 20 Marks Factory buildings owned or leased: On 1 January 2017 Etophia purchased a plot of land for R450 000. Erection of a factory on this land commenced on 1 February 2017. It was completed on 30 September 2017 at a cost of R2 500 000 and was brought into use in a process of manufacture on 1 October 2017. As a result of continued unrest in the vicinity of this factory, the board of directors of Etophia decided on 1 March 2019 to dispose of the land and buildings as soon as possible. The land and buildings were sold to a non-connected party on 30 September 2019 for R3 300 000, of which R500 000 was for the land and R2 800 000 for the buildings. Etophia continued to use the land and buildings in its process of manufacture for the period 1 March 2018 to 30 September 2019. In anticipation of the proposed sale, Etophia, entered into a 20-year operating lease agreement with Inco Ltd (a South African taxpayer) for the lease of an industrial site on 1 March 2019. This lease agreement stipulated that Etophia would:

pay a premium of R75 000 on 1 March 2019;

erect a factory on the site at a cost of R2 800 000; and

from 1 March 2019, pay a monthly rental of R20 000. Erection of the factory commenced on 1 April 2019. It was completed on 30 September 2019 and was brought into use on 1 October 2019. The cost of the factory was R3 300 000.

REQUIRED MARKS

(1) Calculate the effect of the information provided above on the taxable income of Etophia (Pty) Ltd for the year of assessment ending 31 December 2019. Show all calculations and round off all amounts to the nearest Rand. Assume that Etophia (Pty) Ltd wants to limit its normal tax liability for the 2019 year of assessment to a minimum and will make any elections available to it in order to achieve this. Refer to applicable legislation.

12

(2) Assume that Etophia (Pty) Ltd entered into the operating lease with the Municipality of Tshwane and not with Inco Ltd as stated in Part A. Discuss the implications of the premium paid and the erection of the factory on the taxable income of Etophia (Pty) Ltd for the year of assessment ending 31 December 2019.

8

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QUESTION 11 (continued) PART B 10 Marks 1. Market research

During January 2019, Etophia decided to do some market research on the consumers’ preferred colour of choice when purchasing suitcases and handbags. The total cost of the market research amounted to R50 000.

The final results of the research showed that smoky grey was definitely the preferred colour of choice.

2. Second-hand plant

On 1 May 2019, Etophia purchased a second-hand plant from Suppa (Pty) Ltd (a connected person) for R220 000. Etophia brought the plant into use in its process of manufacture on the same day. This plant was independently valued at a market value of R225 000 on 1 May 2019.

3. Residential property On 1 November 2017, Etophia bought, from the developer, five (5) of the twenty (20) flats in a newly erected block of flats in the Republic, at a total cost of R300 000 (including VAT) each. All five (5) of these flats were let to employees for a monthly rental of R2 500 each, effective from 1 December 2017. Etophia does not own any other residential units in the Republic.

4. Learnership agreement

Solomon Mathlanga (who is disabled and has a NQF level 6 qualification) has been in the employ of Etophia since 1 January 2019. Solomon receives remuneration of R170 000 per annum. On 1 January 2019 Solomon entered into a 12-month registered learnership agreement with Etophia. He successfully completed the learnership agreement on 31 December 2019.

REQUIRED MARKS

Calculate the implications of all the above transactions on the taxable income of Etophia (Pty) Ltd for the year of assessment ending 31 December 2019.

Show all calculations and round off all amounts to the nearest Rand.

10

Test 2 TAX4861 2014 - adapted

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QUESTION 11 – Suggested solution

PART A (1) R R Factory buildings and improvements to leasehold property

■ Old factory building

Cost of factory buildings 2 500 000 Section 13(1) allowance 2017 (R2 500 000 x 5%) (125 000)

(1) Section 13(1) allowance 2018 (R2 500 000 x 5%) (125 000) Section 13(1) allowance 2019 (R2 500 000 x 5%) (125 000) (125 000) (1)

Tax value 2 125 000 Less: selling price, limited to cost 2 500 000

Recoupment of section 13(1) allowances 375 000 (1)

In terms of section 13(3) this recoupment of R375 000 may be

deferred (see below). It does not qualify for roll-over relief in terms of par 66 of the Eighth Schedule as this paragraph does not apply in respect of buildings. It also does not qualify for par 65 of the Eighth Schedule because it was not disposed of by expropriation, theft or destruction.

Capital gains tax implications

Land:

Proceeds 500 000 Less: Base cost (450 000)

Capital gain 50 000 (1)

Factory building R Proceeds - Received on disposal 2 800 000 - Less: recoupment (375 000) 2 425 000 (1)

Less: Base cost - Cost 2 500 000 - Less: Section 13(1) allowances claimed (375 000) (2 125 000) (1)

Capital gain/loss 300 000

■ New factory buildings Section 11(f) lease premium allowance R75 000/(20yrs x 12mths = 240mths) x 10

OR /20 x 10/12 = R3 125 (3 125) (1)

Section 11(g) leasehold improvement allowance on

contracted value

R2 800 000/(20yrs x 12mths = 240mths – 7mths = 233) x 3) OR /19,42 (20 years – 7 months to complete) x 3/12 = 36 045

(36 052)

(2)

Rental deduction – section 11(a) R20 000 x 10 = R200 000 (200 000) (1)

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R R Section 13(1) annual allowance: Cost of factory 3 300 000 Less: section 11(g) allowance (in total) (2 800 000) (1) Less: section 13(3) deferred recoupment (see above) (375 000) (1)

125 000

Section 13(1) annual allowance: R125 000 x 5% (6 250) (1)

Capital gain/loss Gain on disposal of land 50 000 Gain on disposal of factory building 300 000

Net capital gain 350 000 (1)

Include in taxable income at inclusion rate – R350 000 x 80% 280 000 (1)

15

Max 12

PART A (2)

Section 11(a) and section 23(g) The lease premium and the leasehold improvements will not be deductible in terms of section 11(a) read with section 23(g), as these amounts are capital of nature.

(1)

Sections 11(f) and 11(g) Proviso (dd) to section 11(f) as well as proviso (vi) to section 11(g) both provide that the deductions in terms of these sections will not be available to the taxpayer if the premium paid or value of improvements does not constitute income of the person to whom it is paid or to whom the right to have such improvements effected accrues. Section 10(1)(a) exempts from normal tax the receipts and accruals of the government of the Republic in the national, provincial or local sphere. The municipality of Tshwane will not be taxed on the lease premium received or the value of the leasehold improvements and therefore Etophia will not qualify for a deduction in terms of sections 11(f) and 11(g). Section 11(f) contains an exception to the rule in respect of lease premiums paid in respect of the use of certain lines or cables – Etophia does not qualify for this exception.

(1)

(1)

(1)

(1) Section 12N (1) In terms of section 12N, if a taxpayer incurs expenditure in respect of improvements to land or buildings leased in terms of an agreement with the government of the Republic in the national, provincial or local sphere, the taxpayer will for purposes of sections 11D, 12B, 12C, 12D, 12F, 12I, 12S, 13, 13bis, 13ter, 13quat, 13quin, 13sex or 36 and for the Eighth Schedule, be deemed to be the owner of the improvements. As a result of section 12N the taxpayer will, although he does not qualify for the application of sections 11(f) and 11(g), qualify for a section 13 deduction in respect of the improvements.

(1)

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Section 13

Section 13 provides for a deduction in respect of buildings and improvements used in a process of manufacture in the course of any trade other than mining or farming. Proviso (d) to section 13(1) provides that in the case of an improvement as contemplated in section 12N, the expenditure incurred by the taxpayer to complete the improvement shall for the purposes of section 13 be deemed to be the cost to the taxpayer of any building or improvement. Etophia will thus qualify for a deduction of: R3 300 000 – R375 000 (recoupment) x 5% = R146 250.

(1)

(2)

10

Max 8

R R PART B

1 Market research Deductible under section 11(a) (50 000) (1) 2 Second-hand plant Section 12C applicable as second-hand plant used in

manufacturing process (from connected person – no effect on cost).

Section 12C allowance based on lesser of cost (R220 000) or cash cost in an arm’s length transaction (R225 000):

Therefore section 12C allowance calculated on R220 000

R220 000 x 20% (second-hand plant) (44 000) (2)

3 Residential units R

Residential units rented

Rent received R2 500 x 5 x 12 months 150 000 (1)

Section 13sex is applicable as Etophia owns at least 5 residential units within the Republic. Cost R300 000 each (VAT not deductible as exempt supply), thus less than R350 000 each. Rent is R2 500 per month each, thus less than 1% of cost.

The units qualify as “low-cost residential units”, as defined in section 1 of the Income Tax Act.

(1)

R300 000 x 10% x 55% x 5 = R82 500 (82 500) (3) (Note that for the purpose of testing for the 1%, cost can be

increased with 10% for each year succeeding the year in which the apartment is first brought into use. Thus for cost use: (R300 000 x 10% x 2) + R300 000 = R360 000).

4 Learnership agreement Salary – Solomon (170 000) (1) Annual allowance – R60 000 (i.e. R40 000 + R20 000) (section

12H(2)(a) read with 12H(5))

(60 000) (1)

Completion allowance – R60 000 (i.e. R40 000 + R20 000) (section 12H(3) read with 12H(5))

(60 000)

(1)

11

MAX 10

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QUESTION 12 Mr Solute Kerzner acquired equity shares in a company listed on the Johannesburg Securities Exchange (JSE Ltd) on 10 December 2015. At the time of acquisition, he intended to hold these shares as an investment. However, during July 2017, he changed his intention to that of speculating with listed shares, thereby effectively commencing to carry out a scheme of profit-making by trading with such shares. On 5 April 2018, these shares’ prices reached an all-time high and he disposed of the shares at a considerable profit. Details of these shares are as follows: R Cost price 10 000 Value at the time of changing his intention 40 000 Proceeds on disposal 100 000

REQUIRED Marks

(a) Briefly discuss whether the proceeds on the disposal of the listed shares during the 2019 year of assessment will constitute gross income in his hands. Refer to relevant case law.

(b) Explain the normal tax (including capital gains tax) implications (if any) that will flow

from the change of intention by Mr Kerzner during the 2018 year of assessment.

(c) Indicate whether your answer to (a) will be different if the acquisition date was 10 December 2014 (and not 10 December 2015) and, if so, indicate in what way.

4

3

3

QUESTION 12 - Suggested solution (a) The proceeds on the sale of the shares will only constitute gross income if it is revenue in nature.

The intention of the taxpayer with regard to the shares will determine the capital or revenue nature of the proceeds. Initially, when the shares were bought, the taxpayer’s intention was to hold the shares as an investment (and earn dividend income), thus as a capital asset (“tree v fruit” – Visser’s case). However, the taxpayer’s intention changed in the course of the 2018 year of assessment from holding the shares as an investment to that of dealing in shares. The taxpayer has “crossed the Rubicon” (Natal Estates case) with no distinction between an investment and a speculative portfolio. Accordingly, the proceeds on the sale of the shares are revenue in nature and constitute gross income. (4)

(b) In terms of paragraph 12(2)(c) of the Eighth Schedule, Mr Kerzner will be treated as having dis-

posed of his capital asset (the listed shares) for proceeds equal to its market value at the time of such change of intention (R40 000) while, in terms of section 22(3)(a)(ii), he will also be deemed to have acquired trading stock at a cost equal to that same market value (R40 000). The deemed disposal of the capital asset will result in a capital gain of R40 000 (deemed pro-ceeds) less R10 000 (base cost) = R30 000 for Mr Kerzner. In turn, Mr Kerzner will hold such shares (from the time of changing his intention) as part of his trading stock. (3)

(c) Yes, it would differ. The shares would then constitute “qualifying shares” in terms of section 9C of

the Income Tax Act and section 9C will apply to deem the proceeds on disposal of the shares to be capital in nature as it was held for more than three years (notwithstanding the fact that it was held with a speculative intention). The proceeds will thus not constitute gross income, but it will be subject to capital gains tax. (3)

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QUESTION 13 See AQSAT Question 16.8 QUESTION 13 - Suggested solution

1. Section 23(o)(ii) of the Income Tax Act prohibits the deduction of fines for any unlawful activity and would cover fines imposed by legislation. However, in this case the fine is not imposed by legislation and the prohibition of section 23(o)(ii) does not apply. The issue that arises is whether the fine has been incurred “in the production of income”. It is submitted that this requirement is satisfied, as it is an inevitable concomitant of Wizard’s income-earning activities, i.e. in horseracing there may be times where the jockey cannot keep the mount on a straight course with resultant interference. It is therefore submitted that Wizard Whipp will be able to deduct the fine. (4)

2. The issue in question is whether the expenditure in question is capital or revenue in nature. The campaign and election expenses were incurred to secure his seat (the income generating asset), which is capital in nature, and the related expenditure is therefore not deductible (New State Areas). No specific deductions exist for expenditure of this type and so no deduction is permitted. (3)

3. The groceries are used for both trade and non-trade purposes. The cost should be apportioned and only the portion relating to the experimental-type meals is deductible (section 23(g)). The onus of proving the apportionment would rest with Betty. If Betty derives 'remuneration' from her articles section 23(m) would prohibit a deduction. (3)

4.

The purpose of the borrowing was to generate income and the interest incurred from the date the flats were made available for letting will therefore be deductible under section 24J as it was incurred in the production of income (PE Electric Tramway Co Ltd v CIR). However, the “trade” requirement must be considered. The interest incurred before the flats were available for letting may be deducted in terms of section 11A on the assumption that Cluster Homes had not commenced trading before the flats were let. The section 11A deduction is deferred and claimed in a lump sum in the year in which the trade commences. The remaining interest could be claimed in terms of section 24J i.e. interest incurred after trading had commenced. Ignore s 24J as it will be covered in TL106

(4)

5. Although the trip is a vacation for Maha and his friend, it is not a vacation taken by the employer. It is important to distinguish the employer from the employee. Moodley’s Manufacturing Co (Pty) Ltd has incurred an expense in respect of the cost of employment of one of its employees. The expense is in the production of income (employees produce income for the employer) and is not of a capital nature. The full amount is deductible in terms of section 11(a) read with section 23(g). (3)

6. George is a resident of the Republic and is taxed on his worldwide income (including his Zambian income). Expenditure incurred in the production of this income is deductible. Note that section 20 prohibits the set-off of non-South African losses against South African income. (The Zambian losses if any, would be ring-fenced). The R50 000 should therefore be utilised against income from his Zambian farm, and any net loss carried forward for use against future taxable income from outside South Africa. (3)

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7. The R2 000 is a “once-off expense from which future benefits will flow” (George Forest Timbers), being the restoration of a capital asset. It is capital in nature as it adds to the income-earning structure of the taxpayer, therefore it is not deductible. The R250 monthly payment is incurred to maintain her income-earning structure and, therefore, not of a capital nature and may be deducted. There is an argument that the deduction may constitute expenditure on the maintenance of the taxpayer and so be disallowed in terms of section 23(a) [note that if you follow this argument, marks will be awarded]. If Fanny derives 'remuneration' from her modelling, the expenditure will not be deductible against this income in terms of section 23(m). (6)

8. The subscription is used for both trade and non-trade purposes. The cost should be apportioned and only the trade portion deducted for income tax purposes (section 23(g)). A 50:50 split may be appropriate. The onus of proof rests on Dr Longwaite. (3)

9. The computer and printer are capital assets and the cost of purchasing them is not deductible under s11(a) [a s11(e) write off for capital assets would apply]. The cost of paper and printer cartridges may be deducted as they are incurred in the production of income and are not capital in nature. (4)

10. The fines may be incurred in the production of income. However since the fines are imposed by legislation, (unlawful to overload transport vehicles) the deduction will not be permitted (prohibited in terms of section 23(o)). (3)

(36)

QUESTION 14 See AQSAT Question 16.9 (ignore case study 6) QUESTION 14 - Suggested solution

1. The travelling expenses are expenses incurred for the purpose of acquiring a capital asset (to add to the income-earning structure). They are therefore regarded as being of a capital nature and are not tax deductible in terms of section 11(a) read with section 23(g).

(2)

2. The advertising expenditure is non-capital (revenue) expenditure actually incurred during the year of assessment in the production of the income and it is therefore deductible in full. It is not necessary that the income must be produced in the year when the expenditure was incurred. Therefore, the expense qualifies for deduction in terms of the general deduction formula. Note - this part is not Required (Question refers to the “general deduction formula” specifically): However section 23H will apply to allow as a deduction each year only the proportion of the expenditure for which benefits have accrued. As the benefit extends more than 6 months after year-end and the amount is more than R100 000, the deduction can only be claimed in respect of the portion relating to services rendered in each year.

(3)

3. The deduction of R3 600 from income would not be allowed because the cost incurred in placing a child in a day nursery was not incurred in carrying on the business of a typist (not incurred in the production of income). It is therefore not deductible in terms of section 11(a) read with section 23(g). Furthermore, because it is a domestic or private expense it is also not allowed as a deduction from income in terms of section 23(a).

(3)

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4. The subscription to the income tax service incurred by Percival Caster represents trade subscriptions. These are deductible from income in terms of the general deduction formula, being laid out for the purpose of earning his trade income and not of a capital nature.

(3)

5. Travelling expenses between a taxpayers’ home and his business are not trade expenses (they are private). Travel between an office and clients is clearly a trade related expense. The situation is more complex where the travel is between one business and another separate business which is not related to the first. It is submitted that SARS will probably regard such travel as not being trade related and will consequently not allow a deduction.

(3)

6. Ignore as topic will be covered in TL107

7. The Alsatian has been purchased for trade purposes (to perform the duties of a watchdog). The R3 000 paid for the purchase of the dog is a capital expense - a one-time expense from which an enduring benefit will flow. The R3 000 is therefore not deductible. The monthly cost of maintaining the dog (R600 to feed him each month) does not create an enduring benefit, and is an expense which is a necessary concomitant of the taxpayer's trade, and is therefore deductible. The R3 400 veterinary surgeon's account are expenses which are likely to recur from time to time and therefore will also be deductible for normal tax purposes.

(4)

8. Income is produced by the performance of a series of acts, and attendant upon these acts are expenses. These expenses are deductible expenses, provided they are so closely linked to these acts as to be regarded as part of the cost of performing them. It must be expected that Flora Bloom will from time to time incur expenditure compensating her driver when he is bitten by dogs while delivering her flower orders. This type of expense is closely linked to any business involved in delivering goods to homes. The medical expenses of R12 500 would be allowed as a deduction. The R1 000 she paid to him towards new clothing was not necessarily incurred. But the words of the statute are "actually incurred" and not "necessarily incurred" and as Flora Bloom actually paid Simon the amount it will therefore be allowed as a deduction.

(4)

26

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ADDITIONAL QUESTIONS AND SUGGESTED SOLUTIONS

QUESTION 15 50 marks Peter Molantoa (55 years of age) is a local businessman residing in Modimolle, Limpopo Province, South Africa. He owns and manages the following two separate business enterprises as a sole proprietor: Business enterprise 1: Manufacturing, packaging and retailing of Sorghum Malt (Sorghum business) Business enterprise 2: Letting of business and residential properties (Rental business) Both business enterprises are registered as separate branches for VAT purposes on the invoice basis. Note: All amounts exclude VAT unless specifically indicated or implied otherwise. Peter wants to pay

the least amount of tax legally possible. The following notes pertain to the two business ventures mentioned above: 1. Factory 1 (Store and drying plant) (Sorghum business) Peter purchased an 80-hectare property situated near the town of Modimolle at a cost of R2 300 000 (open market value) during February 2016 from an individual (a resident, but not a VAT vendor nor a connected person) and immediately commenced with the construction of a large store on the property from which to operate a drying plant for Sorghum Malt. The cost of excavating and levelling the land amounted to R120 000. The cost of the construction of the building (store) amounted to R570 000. The construction of the store was completed on 31 May 2016 and the store in its entirety qualifies as a building used, in a process of manufacture. From 1 April 2016, when the property was registered in his name, Peter has been settling the purchase price in R50 000 monthly instalments on an interest-free basis. A new drying plant was imported from Japan. The cost price of R512 000, correctly translated to SA Rand, was paid on 15 March 2016. Import duties amounted to R75 000 and was also paid on 15 March 2016. The drying plant was installed in the store during June 2016 at a cost of R53 000. Both the drying plant and the store were brought into use on 1 August 2016. In order to improve the industrial capacity of the store, a loading bay was added to the store at a cost of R180 000 and inside the store an office (also part of the store) was constructed at a cost of R95 000. Both these improvements were brought into use on 1 May 2018. The office consisted of 10% of the total floor space of the store and loading bay. 2. Delivery trucks (Sorghum business) Peter purchased and brought into use two delivery trucks (Truck 1 and Truck 2) at a cost of R230 000 each on 1 August 2017 and financed it with two suspensive sale agreements at African Bank. Monthly instalments amounted to R6 777 (including VAT) per truck, payable from 1 August 2017. The interest portion of the amortisation of instalments number 8 (March 2018) to number 18 (January 2019) is R20 849 for truck 1 and for instalments number 8 (March 2018) to number 19 (February 2019) it is R22 472 for truck 2. These trucks may be written off over 4 years in terms of Binding General Ruling No 7 (or Interpretation Note No 47). Truck 1 was completely written off in an accident on 30 January 2019 (after instalment number 18 of the finance agreement was paid). Peter was indemnified by his insurance company on 1 February 2019 when the insurance company deposited R210 000 into his bank account.

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QUESTION 15 (continued) 3. Factory 2 (Sorghum business) In the past Peter purchased germinated sorghum (to be placed in the drying process), but he has now decided to germinate his own sorghum (a process of manufacture) as he could purchase it at favourable prices from local farmers. Peter entered into a 5-year lease agreement with the owner (not a tax exempt entity) of a stand in the industrial area of Modimolle for the right of use of the property from 1 June 2018. In terms of the lease agreement Peter was obliged to effect improvements to the property to the value of R600 000. The improvements consisted of the laying (pouring/constructing) of level and connecting blocks of concrete over an area of 600m2. These improvements will qualify as a building used in the process of manufacture. Peter commenced with the laying of the connecting blocks of concrete on 1 June 2018 and it was completed and brought into use by the Sorghum Business on 1 September 2018 at a cost of R850 000. 4. Residential units (Rental business) Peter purchased 4 residential units with a cost price of R550 000 each in a new residential development on the outskirts of Modimolle in January 2018. The properties were all registered in his name on 1 April 2018 and immediately placed in the rental market by a rental agent. Two of the properties (units 1 and 2) were let from 1 June 2018 and the other two (units 3 and 4) only from 1 July 2018. The rent per unit is R5 500 per month. The properties were financed by way of mortgage loans at a local bank. The interest on the mortgage loans was incurred as follows: Units 1 and 2 1 April 2018 to 31 May 2018 R16 488 1 June 2018 to 28 February 2019 R73 558 Units 3 and 4 1 April 2018 to 30 June 2018 R24 713 1 July 2018 to 28 February 2019 R65 333 5. Office building (Rental business) Peter purchased a newly developed office building directly from a developer (a VAT vendor) at a total inclusive cost of R6 555 000 on 1 October 2018 and paid a R500 000 deposit on the same date. The balance of R6 055 000, which was paid on 2 January 2019, was financed by a bank loan over a 20-year period with fixed monthly repayments of R54 478 payable from 31 January 2019. The fixed yield to maturity rate on this finance is 0.75% per month. The building was registered in Peter’s name on 2 January 2019 and he immediately entered into a 10-year lease agreement with a Provincial Government Department whereby the Department leases the building from Peter at a monthly rental of R85 000 from 1 February 2019. By 28 February 2019 Peter had not yet received any payment from the Department, but he was still hopeful that he would eventually receive payment. On 2 January 2019 he paid the short-term insurance on the building for a period of 12 months (evenly incurred) in advance. The total premium amounted to R136 800. 6. Laptop purchased (Rental business) A laptop with a cost price of R20 700 (VAT included) was purchased and brought into use by the rental business on 1 February 2019. Laptops may be written off over 3 years in terms of Binding General Ruling No 7 (or Interpretation Note No 47). You may assume that SARS will accept a turnover based method ratio of 80% for commercial rentals and 20% for residential rentals.

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REQUIRED Marks

(a) Discuss, supported with calculations, the VAT effect of the purchase of the property in note 1 for the Sorghum business. You also need to indicate when input tax (if any) may be claimed. You are not required to refer to legislation in your discussion. You must assume that current legislation applies.

4

(b) Calculate the Income Tax effect of the transactions in notes 1 to 3 for the Sorghum business for the year of assessment ended 28 February 2019. If a specific item has no Income Tax effect, this should be indicated together with reasons for it.

19

(c) Indicate, with reasons, how your answer to part (b) will differ if Peter constructed the building used in the process of manufacture (Factory 2 in note 3) on land owned by the municipality (a local government and a tax exempt entity).

4

(d) Indicate, with reasons, how your answer to part (b) will differ if Peter constructed an office building instead of a building used in a process of manufacture (Factory 9 in note 3) on the leasehold property owned by a taxpaying entity.

2

(e) Discuss, supported with calculations and relevant references to the Income Tax and VAT Acts, the Income Tax and VAT effect for Peter if he decides to sell the property, including the store and the improvements (Factory 1), on 1 April 2019 to an unconnec-ted person, but excluding the drying plant which will be moved to different premises (refer note 1). Peter will reinvest the full proceeds from the sale of the store and improvements in a similar replacement asset (also a store to be used solely in a process of manufacture) within a period of 4 months. The expected selling price is R2 400 000 (excluding VAT) for the property and R840 000 (excluding VAT) for the store (factory 1). The tax value of the store and improvements have already been correctly calculated as R703 500 as at 1 April 2019. The total cost price for the store and improvements amounted to R845 000 (excluding VAT) on 1 April 2019 (note 1). You may ignore any capital gains tax consequences of these transactions.

6

(f) Calculate the income tax effect of the transactions in notes 4 to 6 for the Rental busi-ness. If a specific item has no income tax effect, this should be indicated together with a reason for it.

15

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QUESTION 15 - Suggested solution

(a) VAT effect on purchase of land

Notional input tax can be claimed on the land purchased as it is second-hand goods from a non-vendor (a supply that is not a taxable supply) (1)

The notional input tax should be claimed as the tax fraction (15/115) with no apportionment as the land will be used entirely (100%) for enterprise purposes to make taxable supplies.

Value of supply in terms of par (b) of the definition of 'input tax' will be the lower of the consideration in money or the open market value - both constituting R2 300 000 in this case.

R2 300 000 x 15/115 = R300 000 (1)

Time of supply in terms of section 9(3)(d) is the earlier of registration or the date of any payment - 1 April 2016. (1)

However, in terms of section 16(3)(a)(ii)(bb)(A) the input tax may only be deducted when the property has been registered and then only to the extent that payment, which reduces the obligation, is made (section 16(3)(a)(iiA)).

Therefore, the notional input tax may be claimed in every VAT period when a R50 000 payment is made OR R50 000 x 15/115 = R6 522 (1)

4

(b) Income Tax effect of the Sorghum business (transactions in notes 1 and 3)

R

1 Plot of land purchased - no deduction

Capital expenditure - forms part of base cost for CGT purposes - no deduction for income tax. Also no deduction for repayments made on the loan as there is no interest portion to deduct. - (1)

Store (building used in the process of manufacture)

Section 13(1) allowance - R570 000 x 5% (28 500) (1½)

Cost of excavating and levelling of the land is regarded as a capital expenditure (R120 000) (SARS practice) - no allowance. - (½)

Drying plant (new)

Section 12C allowance – [R512 000 + R75 000 + R53 000] = R640 000 x 20% (40:20:20:20) – yr 3 (128 000) (2)

Loading bay (building used in the process of manufacture)

Section 13(1) allowance - R180 000 x 5% (9 000) (1)

Office inside store (improvements made to offices in a manufacturing building do not qualify for s 13, since they will not be effected for the purpose of increasing or improving the industrial capacity of these buildings) - (1)

The building is still mainly used in the process of manufacture

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QUESTION 15 - Suggested solution (continued) R R

2 Delivery truck (2)

Section 11(e) allowance - February 2019 - R230 000 / 4 years (57 500) (1)

Interest incurred (section 24J) (22 472) (1)

Finance charges (s 24J) will be covered in TL106

Delivery truck (1)

Cost 230 000

Less: wear and tear - Feb 2018 (R230 000 / 4y x 7/12m) (33 542) (1)

Less: wear and tear - Feb 2019 (R230 000 / 4y x 11/12m) (52 708) (52 708) (1)

Tax value 143 750

Interest incurred (section 24J) (20 849) (1)

Finance charges (s24J) will be covered in TL106

Insurance proceeds (R210 000 x 100/115) 182 609 (1)

Less: tax value (143 750) (1)

Recoupment - section 8(4)(a) 38 859 38 859 (1)

CGT calculation: Proceeds = R182 609 less R38 859 (recoupment) = R143 750 less Base cost = R143 750 (R230 000 – (R33 542 + R52 708) (s11(e) (allowances)) Capital gain/(loss) = Rnil. -

(1)

3 Factory 2 - leasehold improvements

Section 11(g) allowance on leasehold improvements

R600 000 / (60 mnths – 3 mnths) x 6 mnths (63 158) (2)

Section 13(1)(b) allowance on excess improvements

R250 000 (i.e. R850 000 - R600 000) x 5% (12 500) (1)

19

(c) Construction on leasehold land owned by the municipality

No section 11(g) allowance can be claimed as the improvements will not be income in terms of par (h) of the gross income definition in the hands of the municipality in terms of section 11(g)(vi).

(2)

However, in terms of section 12N, the lessee is deemed to be the owner of the leasehold improvements and therefore Peter will qualify for a section 13(1) allowance of 5% on the cost price of the improvements of R850 000.

(2)

Total 4

(d) Construction of offices instead of building used in the process of manufacture

No section 13quin allowance will be available on the amount of improvements exceeding the R600 000 according to the agreement as the taxpayer needs to be the owner of the improvements to qualify for the section 13quin allowance. (2)

The taxpayer still qualifies for the section 11(g) allowance on the first R600 000 of the improvements..

2

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(e) Income Tax and VAT effect on the selling of the land and the store

VAT effect:

Output tax must be levied on the selling price of both the property and the store at 15% as the assets form part of the enterprise and were used to make taxable supplies. Section 7(1)(a) of the VAT Act.

(1)

(R2 400 000 + R840 000) x 15% = R486 000. (2)

This is NOT the sale of a going concern.

Income tax effect:

Recoupment in terms of section 8(4)(a) of the Income Tax Act of R840 000 - R703 500 = R136 500. (2)

CGT: Proceeds (R2 400 000) less-Base cost (R2 300 000 x 100/115) = R400 000 (specifically not required).

BUT, the recoupment does not have to be included in taxable income as a replacement building will be purchased or erected within 12 months from the selling date of 1 April 2019 in terms of section 13(3) of the Income Tax Act. The recoupment will be deducted from the cost price of the replacement asset. (1)

The selling of the land only gives rise to a capital gain as no allowance was claimed (not required).

Par 65 of the 8th Schedule is not applicable as it will not be an involuntary disposal (not required).

Par 66 of the 8th Schedule is not applicable as it does not apply to section 13 assets as is the case under review (not required).

6

(f) Income Tax effect of the transactions in notes 4 - 6 for the Rental business

R

4 Residential units

No section 13sex allowance on residential units let as Peter owns less than 5 units in the RSA -

(1)

Interest incurred (section 24J) - fully deductible as the properties were available for letting from 1 April 2018

Units 1 and 2 - 1 April 2017 to 31 May 2018

(16 488) (½)

Units 1 and 2 - 1 June 2017 to 28 February 2019 (73 558) (½)

Units 3 and 4 - 1 April 2017 to 30 June 2018 (24 713) (½)

Units 3 and 4 - 1 July 2017 to 28 February 2019 (65 333) (½)


Rent received (R5 500 x 2 units x 9m) + (R5 500 x 2 units x 8m) 187 000 (2)

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5 Office building

Section 13quin allowance on building (new and unused)

(R6 555 000 x 100/115 x 5% x 100%) (285 000) (2)

Interest incurred on the loan for January 2019 (R6 055 000 x 0,75%) (45 413) (1)

Interest incurred - January 2019 - may not qualify under section 11(a) due to trade requirement, but could qualify under section 11A (pre-trade expenditure).

Interest incurred on the loan for February 2019 (R6 045 935 x 0,75%) (45 345) (2)

(R6 055 000 + R45 413 - R54 478 = R6 045 935 x 0.75%)


Rent income (accrued) for February 2019 85 000 (1)

Short-term insurance - January 2019 - R136 800 / 12 = R11 400 - may not qualify under section 11(a) due to trade requirement, but could qualify under section 11A (if the requirements of section 11A are met, also can only be deducted from taxable income for rental from office and cannot create a loss)). (11 400)

(1)

Short-term insurance - February 2019 - R11 400 (11 400)

Short-term insurance - March - December 2019 - R114 000 - not deductible (section 23H) as it is for a period of > 6 months and > R100 000. - (1)

6 Laptop purchased

R20 700 - ([R20 700 x 15/115] = R2 700 VAT x 80%) = R20 700 - R 2 160 = R18 540 / 3y x 1m / 12m) (515) (3)

Total 16

Max 15

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QUESTION 16 67 marks This question consists of three related parts. The Crock group of companies consists of four resident companies, all of which have December year-ends and are registered category B VAT vendors (tax periods ending on February, April, June, etc.). All amounts in the question exclude VAT (if applicable), and all parties involved are registered VAT vendors unless specifically stated otherwise. The following companies are members of the Crock group of companies:

Crock Holdings (Pty) Ltd (referred to as Crock Holdings) is the holding company and holds all the shares in the remaining three companies. The company is involved in the residential and commercial property rental market.

Crock Earthmoving Equipment (Pty) Ltd (referred to as Crock Earthmoving Equipment) specialises in the manufacturing of sturdy earthmoving equipment.

Rent a Crock (Pty) Ltd (referred to as Rent a Crock) rents out second-hand motor cars.

Build a Crock (Pty) Ltd (referred to as Build a Crock) sells parts of motor cars as spares and overhauled second-hand motor vehicles.

PART A Information relating to Crock Earthmoving Equipment (Pty) Ltd Crock Earthmoving Equipment is a company that manufactures earthmoving equipment (classified as a process of manufacture by SARS) that is used both locally and internationally by mining and other construction companies. The following transactions relate to the 2019 year of assessment ending 31 December 2019: 1. Crock Earthmoving Equipment launched a new very profitable range of equipment (the “Hot Crock”

range) in July 2019. During the development phase of the new range, the company incurred the following expenses:

Crock Earthmoving Equipment ordered a new manufacturing machine (machine A) from a supplier in France for €250,000 on 1 June 2019 to use in the new manufacturing process. Machine A was shipped free on board (FOB) on 15 June 2019 and was delivered at Crock Earthmoving Equipment’s premises on 25 June 2019. The payment for the machine was made to the supplier on 15 June 2019. The correct amount of VAT and import duties of R25 000 were paid on importation. The company had to erect a supporting structure at a total cost of R17 500 to support the machine before it was brought into use on 1 July 2019.


Date Spot rate €1 = R

1 June 2019 €1 = R10,75

15 June 2019 €1 = R10,70

25 June 2019 €1 = R10,68

1 July 2019 €1 = R10,60

31 December 2019 €1 = R9,70


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Registration fee paid for the Hot Crock trade mark (paid on 31 May 2019) R455 794

Crock Earthmoving Equipment bought a second-hand manufacturing machine (machine B) from an independent party for R2 150 000 (equal to its market value) on 20 June 2019 for use in the new manufacturing process. Crock Earthmoving Equipment was unable to find this type of machine from any other party and could not start the new manufacturing process without this machine. Machine B was brought into use on 1 July 2019.

1. Crock Earthmoving Equipment imports steel-enforced tyres that are used in the production of the Steel Crock earthmoving range of equipment from a supplier in America. Every construction vehicle is fitted with 8 tyres. Crock Earthmoving Equipment ordered 8 000 tyres, at a cost of $25,50 per tyre on 15 November 2018. The tyres were shipped CIF (cost-insurance-freight) on 1 December 2018. On 1 December 2018, Crock Earthmoving Equipment entered into a 2-month forward exchange contract (FEC) with Support Bank Limited in order to hedge the full purchase price. The tyres arrived in South Africa on 21 December 2018 and were immediately cleared and released by customs. Import duties of R64 220 were paid, as well as the correct amount of VAT. 95% of this material was still on hand at the beginning of the 2019 year of assessment and none of the material was on hand at the end of the 2019 year of assessment. The outstanding debt was settled in full on 31 January 2019.


Date Spot rate $1 = R

15 November 2018 $1 = R8,80

1 December 2018 $1 = R7,83 $1 = R8,50 (forward rate under

a 2-month FEC)

21 December 2018 $1 = R8,85

31 December 2018 $1 = R7,75 $1 = R8,00 (forward rate under

a 1-month FEC)

31 January 2019 $1 = R8,10


2. Two forklifts from the Steel Crock earthmoving range were taken from manufactured stock on 1 March 2019 and were used in the factory to move heavy materials from that date. These forklifts have a cost price of R80 000 each and a mark-up of 50% is added on the cost price when sold. Binding General Ruling No 7 (or Interpretation Note No 47) allows for a 4-year write-off period on these forklifts. The market value of the forklifts has at all times been equal to its selling price.

4. Since 1 April 2016, Crock Earthmoving Equipment leased a delivery truck (with a cost price of R780 000) from Rentals Limited, a non-connected company, for R25 000 per month in terms of a three-year lease agreement. The agreement stated that Crock Earthmoving Equipment will be permitted to continue using the delivery truck at the end of the three-year period for a rental of R3 000 per month. The Commissioner will allow Crock Earthmoving Equipment to write off the delivery truck over 2 years (the remaining useful life from 1 April 2019), if applicable.

5. The current factory building was erected by Crock Earthmoving Equipment at a cost of R5 500 000 and brought into use on 1 June 2017. 25% of the total floor space of the factory building is used as offices by the administrative staff and the remainder is used for manufacturing.

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QUESTION 16 (continued) 6. On 1 October 2019, a part of the factory was flooded during a heavy rain storm and machine B (see

note 1 above) and one of the forklifts taken from stock (see note 3 above) were irreparably damaged in the process. On 15 October 2019, an amount of R1 840 000 (after taking VAT implications into account) was received from the insurance company (R1 770 000 for machine B (which was insured at its replacement value) and R70 000 for the forklift). The production manager immediately started looking for a replacement machine and purchased manufacturing machine C (new) for R1 850 000 on 1 November 2019. Machine C was immediately brought into use in the manufacturing process. The forklift was not replaced.

7. Crock Earthmoving Equipment paid R800 000 to Ex Crock, a former employee who left the employ

of Crock Earthmoving Equipment, on 1 November 2019 as a restraint of trade on the condition that Ex Crock will not exercise a trade, profession or occupation in mining and construction for the next five years.

8. Crock Earthmoving Equipment has been assessed as follows for Income Tax purposes for the previous 2 years of assessment:

Tax year Date of assessment Taxable income 2017 15 May 2018 R16 500 000 2018 22 July 2019 R18 650 000

On 30 June 2019, Crock Earthmoving Equipment estimated that its taxable income for the 2019 year of assessment would be R18 000 000. On 23 December 2019, at the close of business for the December holidays, the company estimated that the taxable income for the 2019 year of assessment would be R20 000 000. On 31 March 2020 when the final financial statements had been audited and the final Income Tax calculation had been performed, the taxable income for the 2019 year of assessment was calculated as R20 134 560 (you can assume that this is correct).

REQUIRED Marks

(1)

Calculate the normal Income Tax implications of transactions 1 to 7 for Crock Earthmoving Equipment (Pty) Ltd for its 2019 year of assessment. Show all your calculations and round off all amounts to the nearest rand. Provide brief explanations to support your calculations and clearly indicate (with a brief reason) when no adjustment for Income Tax purposes is required. Assume that the company will elect any option available to minimise its tax liability.

32

(2)

Calculate the second and third (if applicable) provisional tax payments that the company should have made according to the Fourth Schedule of the Income Tax Act for the 2019 year of assessment. Ignore any interest or penalties.

7

(3)

Mr Crock (aged 37), founder of the Crock group, is living a life of leisure after making his fortune when selling his 100% shareholding in Crock Earthmoving Equipment (Pty) Ltd to Crock Holdings (Pty) Ltd 5 years ago. Since the sale of the shares, Crock Holdings (Pty) Ltd pays an annual amount of R2 500 000 to Mr Crock, a former employee of Crock Holdings (Pty) Ltd (he retired immediately after the sale of the shares) as payment for his shares. The annual payment will be payable for the rest of his life. Provide a fully substantiated tax opinion regarding the deductibility for tax purposes for Crock Holdings (Pty) Ltd of the annual payment made to Mr Crock for the 2019 year of assessment. Discuss the deductibility in terms of the provisions of the Income Tax Act and fully substantiate your opinion. Refer to relevant case law.

12

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QUESTION 16 (continued) PART B Information relating to Build a Crock (Pty) Ltd Build a Crock purchases damaged second-hand vehicles and then either sells parts of these vehicles as spares or repairs these vehicles and sells them as second-hand vehicles. These vehicles are mainly bought from insurance companies after being damaged in accidents to such an extent that 80% of the cost to repair these vehicles is more than their book value. If Build a Crock comes across a bargain, it will occasionally buy used motor vehicles from second-hand motor dealers. After overhauling the vehicles, it sells the vehicles at a profit to the public. Before taking into account the income tax effect of the transactions below, as well as the assessed loss of R250 000 brought forward from the 2018 year of assessment, Build a Crock has a loss of R24 300 for income tax purposes on 31 December 2019. Transactions 1. On 1 January 2019, Build a Crock received a machine (not a machine used in the process of

manufacture) as a donation from Jake Blue, a 30% owner of shares of Crock Holdings. Jake carries on a business as a sole proprietor in the repairing of motor vehicles and intends to replace the machine with a newer model. He originally acquired the machine on 1 January 2017 for R275 000. The tax value of the machine on the date of the donation was R137 500, while the market value was R285 000 on this date. Binding General Ruling No 7 (or Interpretation Note No 47) allows for a 4-year write-off period on this type of machine.

2. As Build a Crock is experiencing financial problems, Crock Holdings and Build a Crock reached a

compromise in accordance with which Crock Holdings wrote off a loan of R100 000 and interest of R10 000 on the loan which it had advanced to Build a Crock on 1 March 2019.

Build a Crock had used the funds received in respect of the loan from Crock Holdings to finance operational expenses that the company had claimed for income tax purposes in terms of section 11(a) of the Income Tax Act. The R10 000 interest owing to Crock Holdings has been claimed by the company for income tax purposes.

REQUIRED Marks

Calculate the taxable income or loss of Build a Crock (Pty) Ltd for the 2019 year of assessment.

6

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PART C Information relating to Rent a Crock (Pty) Ltd Rent a Crock entered into the following agreements for the 2019 year of assessment:

On 1 September 2019, Rent a Crock entered into a twelve (12) month agreement with Super Shining (Pty) Ltd. In terms of the agreement, Super Shining (Pty) Ltd will clean the offices from where the rental activities are administered, twice a week at a charge of R5 000 a month (payable in advance). The entire amount for the year of R60 000 was paid on 1 September 2019.

Rent a Crock decided that it wanted to change the exterior appearance of the office building to one with a more modern image. It therefore decided to alter the exterior look of the building, especially the entrance. The company entered into an agreement with Repairs and Improvements (Pty) Ltd for R500 000 on 1 December 2019. In terms of the agreement, work on the office building will commence on 2 January 2020 and should be completed by 31 July 2020. In terms of the agreement, R350 000 was paid on 1 December 2019 and the outstanding amount is payable on the date of completion.

Assume that Rent a Crock made no other prepayments during its 2019 year of assessment.

REQUIRED Marks

Discuss, supported by calculations and with reference to income tax legislation, to what extent (if any) the amounts mentioned are deductible by Rent a Crock (Pty) Ltd in cal-culating the company’s taxable income for the 2019 and 2020 years of assessment. (Assume that income tax legislation for the 2020 year of assessment will remain the same as legislation applicable to the 2019 year of assessment.)

10

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QUESTION 16 - Suggested solution PART A Crock Earthmoving Equipment (Pty) Ltd (1) Effect on taxable income for the 2019 year of assessment R 1 Trademark

registration (s 11(gB)

Full amount allowed (455 794)

(1)

Machine A imported – ss 24I and 12C

Purchase price (s 12C) - capital: (€250,000 x R10,70 (s 25D)) = R2 675 000 Add: R25 000 (import duties) Add: R17 500 (foundation) Total cost = R2 717 500 x 40% (s 12C allowance) No foreign exchange differences since paid on transaction date. Forex (s 24I) will be covered in TL106

(1 087 000)

(1) (½) (½) (1)

Machine B (second-hand) – s 12C

Cost for s 12C is the lesser of cost price (R2 150 000) or cash transaction at arm’s length (R2 000 000), thus = R2 000 000 x 20% (s 12C allowance)

(400 000)

(1)

(1)

2 Material imported – s 24I

Cost of sales (s 11(a) - 2018) ($204,000 (8 000 x $25,50) x R7,83 (s 25D)) + R64 220 = R1 661 540

(2)

Opening stock (s 22(1) - 2019) (R1 661 540 x 95%)

Foreign exchange differences (s 24I) Debt: $204,000 x (R8,10 – R7,75) - loss FEC: $204,000 x (R8,10 – R8,00) – gain

(1 578 463)

(71 400)

20 400

(1)

(2)

(2) 3

Two fork-lifts transferred from stock to assets

No Income Tax implication as manufactured by the company and then transferred to stock (gross income definition par (jA)) – remains trading stock

-

(1)

4 Delivery truck (ss 11(a) and 8(5))

Rental payments until 31 March 2019: 3 x R25 000 Rental payments from 1 April 2019- allowed under s 11(a) (R3 000 x 9) Determination of the fair market value of the delivery truck:

R Cost to Rentals Limited 780 000 Less: 20% depreciation on the reducing balance method per full year (s 8(5)(bB)(i)) 2017: (156 000) 2018: (124 800) 2019: ( 99 840) Deemed fair market value 399 360 (OR R780 000 x 80% x 80% x80% = R399 360)

75 000)

(27 000)

(1)

(1)

(2)

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Delivery truck (ss 11(a) and 8(5)) (continued)

A section 8(5) recoupment, since the annual rental of R36 000 (R3 000 x 12) payable from 1 April 2019 is less than 10% of the fair market value determined above (10% x R399 360 = R39 936), the rental is deemed to be nominal and Crock Earthmoving Equipment is deemed to have acquired the delivery truck for no consideration for purposes of s 8(5)(b). The company must include in its income the lesser of the fair market value of R399 360, or rentals pre-viously deducted of R900 000 (36 x R25 000) (s 8(5)(b) read with s 8(5)(a)) S 11(e) allowance – R399 360/2 x 9/12

399 360

(149 760)

(1)

(2)

(1) 5

Factory – s 13(1)

S 13(1) allowance as mainly (more than 50%) used as factory: R5 500 000 x 5%

(275 000)

(1)

6 Machine B and

forklift destroy-ed – s 12C, 8(4)(e), par (jA) of the gross income defini-tion (s 1) and par 65 of the Eighth Schedule

Forklift – not a capital asset (par (jA) of the gross income definition), trading stock include the insurance pay-out in gross income Machine B: R Purchase price 2 150 000 Less: Wear and tear (s 12C): 20% x R2 000 000 (2019 note 1) (400 000) Tax value 1 750 000 R Proceeds (VAT already excluded) 1 770 000 Tax value (1 750 000) Recoupment 20 000 But can elect par 65 of the Eighth Schedule as proceeds are equal to or greater than base cost (see below) and defer recoupment in terms of s 8(4)(e). Capital gains tax implications R Proceeds 1 750 000 (R1 770 000 – recoupment of R20 000) Less: Base cost (1 750 000) (R2 150 000 – R400 000 (s 12C)) - R1 850 000 x 40% (Machine C: s 12C) Therefore: S 8(4)(e) recoupment on machine B: R20 000 x 40% (same % as machine C)

70 000

-

(740 000)

8 000

(1)

(1)

(1)

(1)

(1) (1)

(1)

133 TAX4862/105

QUESTION 16 - Suggested solution (continued) 7 Restraint of

trade to Ex Crock (s 11(cA) )

The lesser of R266 667 (R800 000/3 years) or R160 000 (R800 000/5 years) will be deductible

(160 000)

(2)

Total 32 (2) Second and third provisional tax payments for the 2019 year of assessment Second

provisional tax payment – due on or before 31 December 2019

Estimated total taxable income for the 2019 year Tax payable (28% x R20 000 000) Less: First provisional tax payment (based on basic amount plus 16% (8% + 8%) as 2017) – (R16 500 000 x 116%) = R19 140 000 x 28%/2 Second provisional tax payment

20 000 000 5 600 000

(2 679 600) 2 920 400

(1) (1)

(2)

Third provisional

tax payment – due on or before 30 June 2020

Actual total taxable income for the 2019 year Tax payable (28% x R20 134 560) Less: First provisional tax payment Less: Second provisional tax payment Third provisional tax payment

20 134 560 5 637 677

(2 679 600) (2 920 400) 37 677

(1)

(1) (1)

Total 7

(3) Tax treatment of the annuity paid to a former employee, Mr Crock Section 11(m) allows for the deduction in full of annuities paid to former employees or partners and their dependants and may be applicable to the annuity paid to Mr Crock. This therefore needs to be addressed first. In this scenario, we have a previous employee, Mr Crock. Section 11(m) will only allow a deduction in respect of a previous employee that retired from employment on the grounds of old age, ill health or infirmity (s 11(m)(i) – since Mr Crock did not retire for any of these reasons, the deduction under section 11(m) will not be available to Crock Holdings). Since section 11(m) is not applicable, the provisions of section 11(a) will have to be discussed.

(1)

(2)

Section 23B(3) provides that no deduction is available under section 11(a) in respect of any expenditure or loss of a type for which a deduction or allowance may be granted under any other provision of the Act, even if the other provision may impose a limitation on the amount of the deduction.

(1) For an amount to be deductible in terms of the general deduction formula, all of the following requirements must be satisfied (i.e. section 11(a) read with section 23(g) of the Income Tax Act):

The taxpayer must carry on a “trade”.

The amount to be claimed must constitute “expenditure or losses”.

The expenditure or loss must be “actually incurred” by the taxpayer during the year of assessment in which it is claimed.

The expenditure or loss must be incurred “in the production of income”.

The expenditure or loss must “not be of a capital nature”.

The expenditure or loss can only be claimed to the extent to which the amount was laid out or expended for the purposes of the taxpayer’s trade.

All of the requirements are met, except for “in the production of income” and “not of a capital nature”, which need to be discussed further.

(1)

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QUESTION 16 - Suggested solution (continued) To determine whether the annuity paid was in the production of income, two questions must be asked:

What action gave rise to the expenditure? The sale of the shares in Crock Earthmoving Equipment and the resignation of Mr Crock gave rise to the expenditure.

Is this action closely connected with the income-earning activities? (Is it a necessary concomitant of the business?) The type of payment appears to be part of the purchase price for the shares, a business was bought which will give rise to income in the future and as such will be closely connected to the income-earning activities.

(Port Elizabeth Electric Tramway Co Ltd case or BP South Africa (Pty) Ltd case)

The annuity paid was therefore expenditure incurred in the production of income. (Alternative: the act entailing the expenditure must be a “necessary/inevitable concomitant” of the taxpayer’s trade) (Joffe & Co (Pty) Ltd case)

(1)

(1)

(1B)

In determining whether the expense is capital in nature, you must establish whether it is part of

the cost of performing the income-earning operations, or

the cost of establishing, improving or adding to the income-earning structure – this payment appears to be a form of adding to the income-earning structure (an additional company or business was obtained) and even though it is paid as annual amounts, it does not change the nature of the payment as being part of the income-earning structure, since the business was purchased to earn income and not for resale at a profit

(New State Areas Ltd case or Rand Mines (Mining & Services) Ltd case) The annuity paid is creating an enduring benefit and thus of a capital nature.

(2)

(1B)

Therefore, the annuity paid to Mr Crock is of a capital nature and Crock Holdings will not be allowed to deduct the amount from its taxable income for its 2019 year of assessment.

(1)

Total 12

Max 10

PART B Taxable income of Build a Crock (Pty) Ltd for the 2019 year of assessment

R R Loss for income tax purposes, before transactions 1 – 3

(24 300) (1)

1. Build a Crock can only claim a s 11(e) wear and tear allowance as it is a non-manufacturing asset* and it has no cost, just a value since it was donated.

Value on 1 March 2019 285 000 (1) S 11(e) - R285 000/4 years (71 250) (1)

*Note: in the case of a manufacturing asset with no cost, s 12C must be applied and the s 12C allowance will be nil in respect of such asset.

2. Recoupment – operational expenses and interest (s 8(4)(a)

together with s 19(5))

110 000

(2)

Assessed loss 2018 (s 20) (250 000) (1)

Tax loss/assessed loss for the 2019 year of assessment (235 550)

Total 6

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QUESTION 16 - Suggested solution (continued) PART C Rent a Crock (Pty) Ltd (a) The R60 000 cleaning expenditure meets the requirements of section 11(a) as the R60 000 is actually incurred, during the 2019 year of assessment, in the production of

income, not being of a capital nature and in the carrying on of a trade.

(1) The R60 000 is deductible in terms of section 11(a), but section 23H might be applicable as

the payment includes a prepaid portion. The prepaid portion is for a period of 8 months (1 January 2020 to 31 August 2020), thus exceeding 6 months after year-end. As the prepaid portion is for a period exceeding 6 months after the end of the year of assessment, we will have to determine the aggregate of all prepaid amounts. The prepaid amount in respect of this agreement is R40 000 (R5 000 x 8 months).

(1)

(1)

(1) The only other prepaid amount is in respect of the amount paid to Repairs and Improvements

(Pty) Ltd.

The R350 000 paid to Repairs and Improvements (Pty) Ltd on 1 December 2019 was not

incurred in respect of the repairs of property occupied for the purpose of trade because of decay or the property being defaced or worn out, but rather to improve the building by giving it a modern look. The R350 000 is therefore not deductible in terms of section 11(d). The amount is also not deductible in terms of section 11(a) as it is capital in nature, being the improvement of the income-earning structure. Therefore, no amount will be deductible in the 2019 year of assessment in respect of the R350 000 paid to Repairs and Improvements (Pty) Ltd on 1 December 2019. The R350 000 + R150 000 (paid on 31 July 2020) will also not be deductible in the 2020 year of assessment as it is capital in nature.

(1)

(1)

(1)

On completion (the 2020 year of assessment) the improvements of R500 000 will qualify for a section 13quin deduction (as they are improvements to the office building), thus R500 000 x 5% = R25 000.

(1) Therefore, section 23H will not be applicable to this prepayment. As the R40 000 is the only prepaid amount that is subject to section 23H, the aggregate of

prepaid expenses is less than R100 000; therefore section 23H will not be applicable.

(1) The R60 000 will be deductible in full in the 2019 year of assessment. (1)

Total 10

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SECTION D: PRIOR YEAR TEST

PRE-TEST REVISION

PURPOSE STATEMENT:

SECTION D contains the Test from the previous year. The objectives of this section are:

to assist you in familiarising yourself with the format in which the tests (summative assessments) are set-out; and

to provide an opportunity to apply your knowledge under exam conditions and practice your exam technique.

Two hours has been allocated to work through this section:

Reading time 15 minutes

The reading time available is for the question part only. Do not read the required until the writing time starts.

Writing time 60 minutes

Start by reading the required and then attempt the question. Time allocated at 1.5 minutes per mark

Debrief time 45 minutes

Take the time mark yourself against the suggested solution and identify areas for revision your knowledge was lacking.

Prior to commencing with this section ensure that you familiarise yourself with the Assessment procedures in TL101 (7.1 to 7.5.2).

The scope of Test 2 covers mainly TL105 topics, as well as the relevant court cases in TL102. Aspects of previous tutorial letters (i.e. VAT in TL103) may also be tested however they will not be the main focus of Test 2.

PLEASE NOTE

Section 24I and 24J will be dealt with in your Tutorial letter 106.

Due to the integrated nature of the questions in this tutorial letter, the parts relating to section 24I and 24J have not been removed.

Once you have mastered the topic in TL106, you can refer back to any of the questions in this tutorial letter in order to prepare for the assessments.

137 TAX4862/105

COLLEGE OF ACCOUNTING SCIENCES

TEST 2: 24 APRIL 2018 READING

PAPER 3: TAX4862/NTA4862 APPLIED TAXATION

(40 Marks)

Time and Duration: 1 hour with 15 minutes reading time. Students MUST be seated by 11:30.

THIRD SESSION

11:30 – 11:45

Handing out of Paper 3 and answer scripts and a separate REQUIRED section placed upside down on the desk.

15 minutes

11:45 – 12:00 Reading time. 15 minutes

12:00 – 13:00 PAPER 3: TAX4862/NTA4862 1 hour

13:00 – 13:15 Collection of Paper 3. 15 minutes

FIRST EXAMINERS: Ms A Heyns SECOND EXAMINERS: Ms AI Becker Ms L Brits Ms N Thoothe

Please ensure that you have completed the cover of the answer book for this question in full i.e. name, surname, student number, code of paper and test number. This TAX4862/NTA4862 (APPLIED TAXATION) question paper consists of 3 pages. The marks allo-cated are 40 marks. THE USE OF A NON-PROGRAMMABLE CALCULATOR IS PERMISSIBLE. This test paper remains the property of the University of South Africa and may not be removed from the test venue.

PLEASE NOTE:

The test is a limited open-book test: Students are allowed to take ONE COPY of the 2017/2018 version of the SAICA Student Handbook or any version published in one of the previous years into the venue. Students should note that the taxation test is set and marked according to the legislation contained in the 2016/2017 version of the SAICA Student Handbook.

Students will be allowed to highlight and to make notes on the question paper and consult their allowed reference books during and after the 15 minutes reading time.

The REQUIRED section must only be turned over once the invigilator announces this.

Round off all amounts to the nearest Rand.

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QUESTION 3 40 marks This question consists of three (3) related parts A, B and C. PART A 32 marks Brickscreator (Pty) Ltd (“Brickscreator”) and its fellow-subsidiary, Bricks-for-All (Pty) Ltd (“Bricks-for-All”), are South African resident companies that manufacture and supply bricks. Brickscreator and Bricks-for-All are wholly owned by another South African company, Buildstrong (Pty) Ltd. The manufacture of bricks is listed by the South African Revenue Service (“SARS”) as a direct process of manufacture. Brickscreator has a September year-end. The company is neither a small business corporation nor a personal service provider as defined in the Income Tax Act. The company is registered for Value-Added Tax (“VAT”) with monthly tax periods and only makes taxable supplies. All amounts include VAT, unless stated or implied otherwise and all parties are VAT vendors. All valid VAT invoices and the requisite supporting documents are in place. The following information relates to Brickscreator’s year of assessment ending 30 September 2019 and has not been taken into account in calculating the company’s preliminary taxable income of R28 370 600 for the 2019 year of assessment. Transactions: 1. On 15 August 2018 Brickscreator purchased six brand new apartments in a residential building that

comprises 25 apartments in total. Brickscreator purchased the apartments directly from the developer (not a connected person to Brickscreator) at a cost of R250 000 each (excluding VAT). As from 1 September 2018 two of these apartments are occupied by Brickscreator’s employees free of charge, whilst the other four apartments are rented out for R3 000 per month.

2. Defective bricks, manufactured in August 2018 and included in closing stock at a cost of R150 000 (excluding VAT) at the end of the 2018 year of assessment and treated correctly in the cost of sales figure for 2019, were donated by Brickscreator to a local charity project on 10 December 2018. No section 18A receipt was obtained in respect of this donation. The market value of the stock donated on 10 December 2018 was R140 000 (excluding VAT).

3. On 31 October 2018, Brickscreator purchased a brand new brickmaking machine (“Machine A”) from a non-connected third party for R480 000 (equal to market value). In addition to the purchase price, Brickscreator incurred transport and installation costs of R7 600 in respect of Machine A. Machine A was brought into use in the manufacturing process on 1 November 2018. On 1 June 2019 Brickscreator purchased, and brought into use, a second-hand brickmaking machine (“Machine B”) that was advertised by a non-connected third party for a special price of R345 000. The open market value of Machine B on 1 June 2019 was R460 000. Brickscreator could not refuse the good deal. At the same time, Brickscreator donated Machine A to Bricks-for-All. Bricks-for-All needed a new brickmaking machine, but could not purchase one due to cash flow problems. The decision was accordingly taken by the directors of Brickscreator to assist its fellow-subsidiary and to donate Machine A to Bricks-for-All. On 1 June 2019, the open market value of Machine A was R598 000. Binding General Ruling No 7 (or Interpretation Note No 47) allows a write-off period of 6 years for brickmaking machines.

4. On 1 July 2019 Brickscreator purchased a new motor car (as defined in the VAT Act) from a non-connected car dealer for R437 000. The motor car was immediately brought into use by the company’s managing director. Binding General Ruling No 7 (or Interpretation Note No 47) allows a write-off period of 4 years for motor cars.

139 TAX4862/105

QUESTION 3 (continued) PART B 6 marks Assume Brickscreator did not donate Machine A to Bricks-for-All. However, Bricks-for-All was still in need of an additional brickmaking machine, but could not afford a new machine as a result of its cash flow problems. Assume Bricks-for-All managed to conclude an agreement with a non-connected third party bank, Randco, whereby Bricks-for-All purchased a new machine, Machine C, for a total cost of R500 000 (excluding VAT) on 1 June 2019. Bricks-for-All then sold Machine C to Randco on 1 July 2019 for R690 000 and Randco in turn leased the machine (under a finance lease with a cash cost of R701 500, VAT inclusive) back to Bricks-for-All for a monthly lease payment of R16 944, for a period of 36 months (commencing on 1 July 2019). Bricks-for-All would acquire Machine C at the end of the lease for R115 000 when the open market value would be R149 500. Bricks-for-All also has a September year-end. Similar to Part A, all amounts include VAT, unless stated or implied otherwise. PART C 2 marks The head of Bricks-for-All’s manufacturing division, Mr Smart, resigned on 31 August 2019 with immediate effect. To prevent Mr Smart from sharing his expertise with competitors of Bricks-for-All, the company immediately paid Mr Smart R250 000 (excluding VAT) for agreeing not to share any company trade secrets with any of Bricks-for-All’s competitors in the market over the next four years. Mr Smart will include this amount in his taxable income for the 2020 year of assessment.

140 TAX4862/105

TEST 2: 24/04/2018

TAX4862/NTA4862 ADVANCED TAXATION

REQUIRED

This is the REQUIRED part of Question 3 of TAX4862/NTA4862 and consists of 2 (two) pages, including this cover page.

141 TAX4862/105

QUESTION This question consists of three (3) related parts (Part A, B and C). PART A

REQUIRED Marks

Sub-total

Total

Calculate, supported with reasons, the normal tax payable by Brickscreator (Pty) Ltd for its 2019 year of assessment. Start your calculation with the preliminary taxable income of R28 370 600 before taking into account the effect of transactions 1 to 4. Show all your calculations. Communication skill - presentation

31 1

32

Total for Part A 32

PART B

REQUIRED Marks

Sub-total

Total

Discuss, supported by calculations and reference to the relevant legislation, the income tax and VAT implications for Bricks-for-All (Pty) Ltd upon expiry of the lease. Communication skill – clarity of expression

5 1

6

Total for Part B 6

PART C

REQUIRED Marks

Sub-total

Total

State whether the payment of R250 000 made by Bricks-for-All (Pty) Ltd to Mr Smart will be deductible by the company in its 2019 year of assessment. Briefly motivate your answer.

2

Total for Part C 2

TOTAL 40

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TEST 2 - SUGGESTED SOLUTION

Market value of R598 000 less VAT (s 18(1) change in use adjustment = output tax) (R598 000 x 100/115) = R520 000, but limited to cost 424 000 (3)

Less: Tax value (254 400)

S 8(4)(a) recoupment 169 600 (1)

Capital gains tax (Eighth Schedule)

Proceeds (par 38 – R598 000 x 100/115) 520 000 (1)

Brickscreator (Pty) Ltd

R

R

Preliminary taxable income (given) 28 370 600 1. Rent received: R3 000 x 4 x 12 mths 144 000 (1)

Cost of each apartment: R250 000 (excl VAT). As residential dwelling acquired for letting – input tax denied (exempt supply for VAT purposes); therefore, cost: R250 000 x 115/100 = R287 500. To qualify as “low-cost residential unit”, cost must not exceed R350 000 and monthly rental must not exceed 1% of cost, i.e. monthly rental must not exceed R2 875 (1% of R287 500). Therefore, two apartments qualify as “low-cost residential units”, as these were occupied free of charge. The other four apartments do not qualify as “low-cost residential units”, as the monthly rental of R3 000 exceeds 1% of cost.

S 13sex allowance: 55% (part of building acquired) x R287 500 x 2 x 10% (31 625) (3)

S 13sex: 55% (part of building) x R287 500 x 4 x 5% (31 625) (3)

2. Opening stock (s 22(2)) – no adjustment (incl. in cost of sales) - (1)

Recoupment of stock donated (s 22(8)) at market value (because no s 18A certificate) 140 000 (1)

3. Cost of Machine A (for purposes of s 12C):

(R480 000 + R7 600) x 100/115 = 424 000

(2)

Transport and installation costs are added to actual cost /purchase price of asset.

Less: Section 12C allowance – R424 000 x 40% (169 600) (169 600) (1)

Tax value on 1/6/2019 254 400

Cost of Machine B (for purposes of s 12C) is the lesser of: R345 000 x 100/115 = (“cost”) 300 000

(1)

Or

Direct cost under cash transaction concluded at arm’s length (i.e. market value. (Open) market value (MV) (given) = R460 000. Acquisition market value less actual VAT = R460 000 – (15/115 x R345 000 = R45 000) 415 000

(2)

S 12C(2) cost therefore, R300 000. S 12C allowance: R300 000 x 20% (as second-hand) (60 000)

(1)

For purposes of s 8(4)(a), s 8(4)(k) deems Machine A to be sold at market value.

143 TAX4862/105

TEST 2 – Suggested solution (continued)

Less: s 8(4)(a) (par 35(3)) (169 600) (1)

350 400

Base cost (par 20 of the 8th Schedule) 424 000 (1)

Less: s 12C allowance claimed (par 20(3)(a)) (169 600) (1)

254 400

Capital gain: Proceeds 350 400

Less: Base cost (254 400)

96 000

Taxable capital gain included below at end of calc 4. Motor car for MD s 11(e)

(No input tax claimed – “motor car” as defined): S 11(e) R437 000 / 4 x 3/12 (27 313) (1)

Output tax on fringe benefit is a salary cost: ((Determined value = R437 000 x 100/115) x 0.3% x 15/115) x 3 mths (446) (4)

3. Taxable capital gain inclusion – 96 000 x 80% 76 800 (1)

Taxable income 28 580 391

Normal tax at 28% 8 002 509 (1)

31

Communication skill - presentation (order of inclusions/deductions and calculating normal tax) 1

Total 32

PART B Bricks-for-All would include a recoupment in gross income of the market value (R130 000, that is R149 500 x 100/115) of the asset less consideration, therefore R130 000 – R100 000 (i.e. R115 000 x 100/115) being R30 000 (s 8(5)(b)).

(2) (1)

No VAT will be payable as it is in terms of the lease agreement and VAT has already been paid. (2) Bricks-for-All will be entitled to a wear-and-tear allowance on the asset acquired in terms of s 11(e) only (because the manufacturing asset does not qualify for s 12C). The s 11(e) allowance will be claimed on the market value of R130 000.

(1)

(1)

Communication skill – clarity of expression (1)

Available 8

Max 6

PART C The payment of R250 000 is capital in nature and will not be deductible in terms of the general deduction formula (sections 11(a) and 23(g) of the Income Tax Act).

(1)

However, section 11(cA) allows for a deduction of the lesser of payment divided by the number of years that the restraint of trade applies or one third; thus, the allowable deduction in Bricks-for-All (Pty) Ltd’s 2019 year of assessment is the lesser of: R250 000 / 4 = R62 500 or R250 000 / 3 = R83 333, therefore Bricks-for-All (Pty) Ltd can deduct R62 500 in its 2019 year of assessment.

(1)

(1)

Available 3

Max 2

________________________________ END OF TUTORIAL LETTER

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