TAX3701 Assignment 2 (DETAILED ANSWERS) Semester 1 2024 - DISTINCTION GUARANTEED

TAX3701 Assignment 2 (DETAILED ANSWERS) Semester 1 2024 - DISTINCTION GUARANTEED - DISTINCTION GUARANTEED - DISTINCTION GUARANTEED Answers, guidelines, workings and references ..... QUESTION 1 (40 marks, 72 minutes) Crystal (Pty) Ltd (“Crystal”) is a South African resident company with a 31 March financial year end. The company is a leading manufacturer and distributor of float glass, laminated glass, and various mirror products to customers in and outside South Africa. Crystal is registered as a category A vendor for Value-Added Tax (VAT) purposes and is not a Small Business Corporation as defined in section 12E of the Income Tax Act no.58 of 1962. The South Africa Revenue Service (SARS) recognises Crystal’s manufacturing processes as approved processes of manufacture. All amounts exclude VAT unless stated otherwise. The following income and expenditure statement was prepared by Crystal’s accountant for the financial year ended 31 March 2024: Notes Amount (R) Income Revenue 1 3 450 000 Cost of sales 2 (887 500) Investment income 3 312 300 Expenditure Depreciation expense 4 (427 640) Payment to Mrs Van Louw 5 (240 000) Net profit before tax 2 207 160 Notes: 1. Revenue from sales made to customers situated outside South Africa amounted to R1 034 000. This amount is not yet accounted for in the above income and expenditure statement. 2. The cost of sales amount was determined as follows: R Opening stock…………………………………….. 404 000 Purchases…………………………………………. 725 000 Closing stock……………………………………… (241 500) Cost of sales………………………………………. 887 500 The accountant was uncertain on how to account for the closing stock. On 31 March 2024, it was found that some of the closing stock items were damaged to an extent that it would be unethical for Crystal to distribute them at discounted selling prices. These closing stock items are included in the above closing stock figure at a total cost of R41 800. 3. During the 2023 financial year, Crystal embarked on a quest to diversify its investments. Below is a summary of the returns earned on the company’s individual investments for the 2024 financial year: • Total interest earned on the company’s only fixed deposit account amounted to R75 000. • Equity shares held in Nexus Works Ltd, a South African resident company, yielded dividends amounting to R140 000. • Dividends amounting to R53 200 were received in respect of the 15% interest held in the equity shares and voting rights of Aurora Innovations, a company based in Sweden. • The 5% interest held in the equity shares and voting rights of Equinox Industries, a manufacturing company effectively managed in France, yielded dividends amounting to R44 100. 4. The depreciation expense relates to the following assets: Asset Acquisition date Purchase price (R) Notes Sebenza building 1 June 2014 R1 520 000 4.1 Specialised delivery truck ?? ?? 4.2 Patent 12 February 2024 R220 000 4.3 Manufacturing machine 1 September 2022 R465 000 4.4 4.1. Sebenza building was acquired on 1 June 2014 at a total cost of R1 520 000 to house Crystal’s manufacturing operations. During the 2024 financial year, a vigorous cost-benefit analysis was performed to evaluate the financial viability of modernising, expanding, and maintaining Sebenza building to meet the sky rocketing demand for glass products. The results of the cost-benefit analysis influenced the decision to sell the Sebenza building and rather obtain the required manufacturing space through a lease arrangement. The Sebenza building was disposed of on 31 July 2023 for R1 200 000. On this date, Yabantu building, a modernised factory building with increased production capacity was leased from Zwillow Rentals (“ZR”), a South African property rental company. The lease agreement signed by both Crystal and ZR contains the following clauses which apply to the lessee: Lease commencement date 1 August 2023 Lease term 15 years with an option to extend the agreement for another five years. Rental R15 000 payable monthly in arrears with a 10% escalation after every 12 months period. Premium R100 000 payable upfront on the commencement date of the lease. The amount is payable once-off. Mandatory improvements Improvements valued at R1 000 000 are to be effected on Yabantu building before the end of the lease term. On the commencement date of the lease, Crystal was uncertain on whether the extension option will be utilised or not. The mandatory improvements on the other hand were completed on 30 November 2023 at a total cost of R1 200 000 (including VAT) and immediately brought into use. Crystal’s accountant did not account for the lease of Yabantu building in the above income and expenditure statement as well as the transaction relating to the disposal of Sebenza building. 4.2. On 1 November 2023, Crystal placed a special order with an American supplier for the acquisition of a specialised delivery truck. The supplier offered Crystal a 12-ton Rigid carrying lorry at a total cost of $117 900. This is a delivery truck with specialised side loading for large double glazed glass products and cut sized glass. Crystal confirmed the order on 20 December 2023. The delivery truck was shipped to South Africa on 12 January 2024 on a free-on-board basis. The ship reached the South Africa harbour on 22 January 2024. Crystal settled the purchase price on 20 April 2024. The following spot rates apply to the period of the transaction: Date Spot rate 1 November 2023 $1 = R18.76 20 December 2023 $1 = R18.46 12 January 2024 $1 = R18.65 22 January 2024 $1 = R19.00 31 March 2024 $1 = R19.25 5 April 2024 $1 = R18.64 Average spot rate for 1 November 2023 to 31 March 2024 $1 = R18.88 The specialised delivery truck was brought to use on 1 February 2024. Despite Crystal intending to use the delivery truck for a period of ten years, the SARS allows a write off period of eight years for specialised delivery trucks. 4.3. Crystal’s research and development team lead by Dr Mansoor, a material scientist, developed a revolutionary type of glass called “Luminex Glass”. This is a type of glass that is embedded with nanotechnology that allows it to dynamically adjust its transparency and colour in response to external stimuli such as light and temperature changes. This invention opens a wide range of applications across the architecture and automotive industries. On 12 February 2024, in recognition of the immense commercial potential of Luminex Glass, Crystal decided to acquire a patent at a total cost of R220 000 to protect its intellectual property rights. 4.4. Crystal owns a heavy-duty machine that is used in the manufacturing of its glass products. The machine was acquired new and unused on 1 September 2022 for a total amount of R465 000. This machine was still on hand on 31 March 2024. 5. A total amount of R240 000 was paid to Mrs Van Louw, a former employee that terminated her services during the 2024 year of assessment. The amount was paid to prohibit Mrs Van Louw from: • Engaging in any business activity that directly competes with Crystal’s business, and • Engaging with Crystal’s clients or employees. The above prohibitions apply for a period of 8 years after Mrs Van Louw’s termination. The following transactions were not taken into account in the above income and expenditure statement: 6. A total amount of R180 000 was paid on 1 December 2023 in respect of insurance premiums for the period 1 December 2023 to 30 November 2024. 7. A learnership agreement was entered into with Ms Jessica Moosa, an employee that was in possession of an NQF level 8 qualification upon signing the agreement. The agreement covered the period effective from 1 June 2021 to 31 May 2023. Ms Jessica Moosa’s disability did stop her from achieving her goals. She met all the requirements of the learnership agreement and successfully completed in record time. 8. Since Crystal allows the sale of some of the goods to clients on credit, the company does sometimes experience difficulty with collecting outstanding amounts from clients. Crystal’s accountant provided the below extract for doubtful debts balances: Year of assessment Amount Notes 2024 R126 700 1 2023 R134 200 2 Notes: 1. 60% of the doubtful debts balance was in arrears for more than 6 months, while the remainder of the balance was only in arrears for less than 30 days. 2. 80% of the of the doubtful debts balance was in arrears for more that 240 days while the remainder of the balance was in arrears for 90 days. During the 2024 financial year, Crystal employed a lawyer to assist with the collection of the outstanding debts. The lawyer was paid an amount of R85 000 in fees for this service. Crystal does not apply IFRS 9 for financial reporting purposes. REQUIRED: Marks Calculate Crystal (Pty) Ltd’s normal tax liability for the 2024 year of assessment. Provide brief reasons for amounts that have a Rnil effect on taxable income. Reference to legislation and court cases is not required. Crystal (Pty) Ltd will elect options that would legally minimise its normal tax liability. 40 QUESTION 2 (15 marks, 27 minutes) Part A (5 marks, 9 minutes) A registered VAT vendor purchased a computer for up to 70% use in providing exempt supplies and 30% use in the course of making taxable supplies. The computer had a total cost of R28 750 (including VAT) when it was acquired. The vendor later sold the computer at its market value of R31 050 (including VAT). REQUIRED: Marks Discuss, supported with calculations, all the input tax consequences arising from the above transaction. 5 PART B (5 marks, 9 minutes) You have recently been employed by a firm of accountants as a tax adviser. The following query regarding a South African resident client has been referred to you: Tsepi Nota (Pty) Ltd (“TN”) carries on a business as a transport contractor, transporting goods all over South Africa. The company also transports passengers (and their personal belongings) to and from Durban and Johannesburg by means of luxurious buses. After receiving numerous complaints from passengers TN now provides a meal and refreshments to all passengers travelling on its buses. TN has contracted with a catering supplier to supply and pre-pack meals and refreshments for this purpose. Each meal will be purchased by TN for R92,00 (i.e., R80 plus VAT of R12). To cover, in part only, the additional cost of the meal, TN will increase its ticket price of a single trip by R20. REQUIRED: Marks TN (a registered VAT vendor) would like to know the VAT implications of the purchase of the meals and the increased ticket price. 5 Source: adapted from UJ Part C (5 marks, 9 minutes) Rest Assured (Pty) Ltd (“Rest”) is a South African resident company situated in Silverlakes, Pretoria. The company specialises in the sale of high-end beds and bedroom furniture. During the two-months period ended on 29 February 2024, the owner, Edwin Muraya, purchased 15 beds to add to their deluxe range at R25 000 each (including VAT). Upon realising that there was not as much demand as he anticipated, he decided to take two of the deluxe beds as Christmas gifts for his two sons. Rest makes 80% taxable supplies. The company sells each deluxe bed for R32 000 (including VAT). REQUIRED: Marks Calculate the output tax and input tax implications (if any) in respect of the beds that Edwin Muraya took for gifting his sons during the two-months period ended 29 February 2024. 5 QUESTION 3 PART A (10 marks, 18 minutes) You are the tax compliance manager of a new company that specialises in the compliance of small businesses in Khayelitsha, Cape Town. You received a letter from Vuyo Mqalo, a young woman with a successful natural hair salon. Vuyo is looking at ways in which she can develop her hair business and has sent you the letter below: REQUIRED: Marks Advise the client based on the query above. In your discussion address the following questions: 1. Do I qualify to register under the turnover tax system for the 2024 year of assessment? 2. Assuming that I do qualify to register under the turnover tax system, how much would my turnover tax liability for the 2024 year of assessment be? 10 PART B (10 marks, 18 minutes) Soothe (Pty) Ltd is a South African company that operates a chain of luxury boutique hotels across major cities in South Africa. In the financial year ended 29 February 2024, Soothe Ltd undertook a Dear Tax Manager, My name is Vuyo Mqalo and am a hairdresser in Khayelitsha, Cape Town. I am writing to you seeking guidance on the best way to structure my business taxes. On 1 March 2022 I opened a natural hair salon called Own Your Crown (Pty) Ltd in the township. I was informed that I was not compelled to register for VAT so I never did. However, I was recently informed that I could qualify as a microbusiness. During the financial year that ended on 28 February 2023, I generated a total income of R750 000 which was really good given that it was my first year of trading. In respect of the financial year ending on 29 February 2024, my income and expenditure were as follows: Income: services rendered R456 000 Income: sale of natural hair products R 37 000 Western Cape government grant R 50 000 Interest received from bank account R 10 500 Proceeds from sale of old hair dryers R 14 500 Purchase of new hair dryers (R 23 600) Rental paid (R 16 400) Various trading expenses incurred (R 44 000) Assessed loss carried forward from 2023 (R3 500) Doubtful debt allowance 2023 (R5 000) I would like you to kindly advise me on the following: 1. Do I qualify to register under the turnover tax system for the 2024 year of assessment? 2. What would my turnover tax liability for the 2024 year of assessment be assuming that I qualify to register under the turnover tax system? I am looking forward to any assistance you may offer me in this regard. Regards, Vuyo Mqalo major renovation of its flagship hotel in Cape Town. The renovation included structural changes to the building to enhance its historical facade, the addition of a new spa and wellness center, and a complete overhaul of its IT infrastructure to implement state-of-the-art guest service technology. The total expenditure for the renovation amounted to R25 million, broken down as follows: • R10 million on structural enhancements to enhance the historical facade. • R5 million on the spa and wellness center. • R10 million on upgrading the IT infrastructure. Soothe Ltd aims to treat the entire R25 million as a deductible expense in its taxable income for the 2024 year of assessment. The company argues that the expenditure is wholly and exclusively for the purpose of its trade and should therefore be deductible under Section 11(a) of the Income Tax Act. REQUIRED: Marks As a tax consultant, you are required to discuss and apply the provisions of Section 11(a) read together with section 23(g) of the Income Tax Act to the expenditure incurred by Soothe Ltd. Your discussion should focus on the following: • Whether the expenditure incurred by Soothe Ltd meets the requirement of being "not of a capital nature" to qualify as a deductible expense. • In your analysis, include references to relevant case law that deals with the distinction between capital and revenue expenditure, particularly focusing on the "capital in nature" aspect. 10 PART C (5 marks, 9 minutes) Majestic Hotels Group (“Majestic”), a prominent hotel chain in South Africa, faced an unusual situation in the 2024 tax year. Due to the upcoming elections in South Africa, various dignitaries were invited to a conference hosted in Johannesburg to resolve the national energy crisis. The hotel experienced a surge in their bookings for the month of January 2024. To manage this high demand, Majestic implemented a non-refundable booking deposit policy. The United States delegates had initially booked 50 rooms for the conference, paid a deposit of R200 000, but cancelled the booking two months later. According to the policy, Majestic retained the deposit paid. This deposit was initially intended to secure the booking and cover potential losses pertaining to cancellations. The hotel did not incur any specific expenses in respect of this booking cancellation as it was able to reallocate the rooms to other guests due to the high demand. Majestic Hotels Group is considering whether the R200 000 deposit should be included in its gross income for the year of assessment ended on 31 March 2024. REQUIRED: Marks Determine whether Majestic Group should include the deposit in its taxable income calculation for the year ended 31 March 2024. You are required to do this by discussing and applying the principles of the Gross income definition as provided in section 1 of the Income Tax Act. Reference to at least one applicable case law and related principle is required.