1 QUESTION 1 75 marks All references are to the Income Tax Act, unless stated otherwise. Arnod Properties Ltd Arnod Properties Ltd (‘Arnod’) is a listed company. It has one million equity shares in issue which are widely held. Arnod is a resident as defined and does not form part of a group of companies as defined. Arnod is a registered value added tax (VAT) vendor and its financial year and tax year of assessment end on the last day of February. Arnod obtained a ruling to determine input tax in accordance with the turnover method where the ratio of taxable supplies to total supplies is 90 : 100. Arnod’s portfolio of investment properties consists of – ? commercial properties (shopping centres and office buildings); and ? residential properties. Information relating to the 2012 year of assessment The following was captured when completing the tax return (IT14) for the 2012 year of assessment. All amounts exclude VAT where relevant: Notes R Income items Commercial properties gross rentals 36 000 000 Residential properties gross rentals 4 000 000 Total rental income (other income) 40 000 000 Interest – financial institutions / other 250 000 Accounting profit on disposal of assets 1 12 000 Expense items Depreciation and impairment 1 3 306 000 Salaries and wages (excluding medical contributions below) 4.1 – 4.7 7 822 000 Medical scheme contributions 4.8 1 200 000 Other (including R800 000 BEE expenses in note 2) 14 788 900 Net profit – subtotal (profit per financial statements) 13 145 100 Debit adjustments Accounting profit on disposal of fixed and / or other assets 1.1 & 4.7 12 000 Special allowances not claimed in the income statement Wear and tear allowance – section 11(e) 1.1 1 556 000 Section 12C(1)(f) aircraft allowance 1.2 2 668 421 Section12N allowance 3 2 340 000 Credit adjustments Depreciation according to financial statements 1.1 & 1.2 1 806 000 Accounting / Fair value adjustments to comply with IFRS 1.3 1 500 000 Provisions not deductible in current year 4.5 53 000 Other (penalty) 4.6 25 000 Recoupment of allowances previously granted 4.7 12 000 Taxable income 9 964 679 2 Notes 1 Depreciation and impairment R 1.1 Depreciation on motor vehicles ? Old company car of the Managing Director (MD) – note 4.8 ? New company car of the MD – note 4.8 ? Other vehicles 60 000 16 000 1 480 000 The depreciation is the same as the wear and tear allowance granted for income tax purposes (section 11(e) read with Binding General Ruling 7). 1.2 A second-hand aircraft was acquired on 1 January 2012 from a non-vendor for a cash payment of R15 million. The aircraft was immediately brought into use wholly for business purposes. Depreciation was calculated as follows: R15 000 000 x 10% x 2/12 250 000 1 806 000 1.3 Arnod has adopted the fair value model for its investment properties in terms of the IAS 40, Investment Property. The buildings (excluding those referred to in note 3) are revalued annually and the fair value adjustment in the current year has resulted in a reduction in fair value of These buildings do not qualify for any tax allowances as they were acquired prior to 1 April 2007. 1 500 000 3 306 000 2 Black Economic Empowerment To acquire the black economic empowerment (BEE) points required to negotiate the lease for the government land (see note 3), Arnod implemented an Economic Empowerment programme (EE Programme) to address the requirements of the BEE scorecard as prescribed by the Broad-Based Black Economic Empowerment Act. The EE Programme entails spending 2% of Arnod’s annual turnover for a period of ten years on a number of small black-owned independent businesses involved in property maintenance. In terms of the programme, Arnod provides mentorship to the business owners and reimburses the participating businesses for agreed upon expenditure incurred by them. The Department of Trade and Industry approved the EE Programme on the basis that the BEE points will be granted annually following a review of Arnod’s compliance with the terms and conditions of the EE Programme. The R800 000 (included in the ‘other’ expenses item on the IT14) represents re-imbursements of claims submitted by the selected businesses in terms of the EE Programme during the 2012 year of assessment. None of these re-imbursements relate to services rendered to Arnod by these businesses. 3 3 Low cost housing On 1 March 2011 Arnod decided to enter the low-cost housing market. The directors identified a tract of land on which to build 100 low-cost residential units. The land identified for the development is owned by the provincial government but is not for sale. However, the provincial government was prepared to enter into a 30-year lease of the land on the following terms: ? Arnod must qualify in terms of the BEE scorecard (see note 2 in this regard). ? A monthly rental of R30 000 is payable in advance. ? The rental is subject to an annual escalation based on the inflation rate. The lease was signed on 1 April 2011 and the first month’s rental was paid on that date. Although Arnod was not obliged to erect low-cost housing on the land, Arnod voluntarily (with the provincial government’s permission) commenced construction of 100 low-cost residential units on 1 July 2011. These units were completed at a cost of R234 000 each on 31 December 2011 and Arnod commenced letting the units on 1 January 2012 for a monthly rental of R2 300. 4 Salaries and wages R 4.1 Deductible salaries and wages (before deducting PAYE but without having taken the items listed below into account) 5 252 000 4.2 Arnod’s share of Unemployment Insurance Fund contributions 60 000 4.3 Bonuses for the year Bonuses accrued to senior management during the year, but were only paid after the year-end. No employees’ tax was deducted from these amounts. 1 500 000 4.4 A gratuitous lump sum was received by the executor on behalf of Mr Arnold Bosch’s estate Mr Bosch was a founding member and senior executive of Arnod who died unexpectedly in December 2011. At a Board of Directors’ meeting in January 2012 the directors of Arnod decided to posthumously (after death) award Mr Bosch a lump sum (his first lump sum ever) as a result of his years of dedicated service to the company. 500 000 4.5 Increase in provision for leave pay 53 000 4.6 Penalties incurred for late payment of PAYE to the South African Revenue Service (SARS) 25 000 4 R 4.7 Other benefits / allowances granted to employees In addition to the non-contributory medical scheme (see note 4.8), Arnod provided the following fringe benefits: ? A monthly travel allowance of R12 000 to each of the three maintenance foremen ? A company car to the MD. Arnod acquired a BMW 320i on 1 March 2010 at a cost of R360 000 (including VAT) and granted the exclusive use thereof to the MD. The BMW 320i was traded in on 1 January 2012 for an amount of R240 000. The trade-in resulted in a profit of R12 000. The company did not make an election in terms of paragraph 66 of the Eighth Schedule. A new BMW 325i was acquired at a cost of R480 000 (including VAT). Neither of these BMW’s had a maintenance plan as contemplated in the Seventh Schedule. The MD is required to pay the cost of private fuel and maintains a logbook to record his mileage. 432 000 Subtotal 7 822 000 4.8 Contributions to the medical scheme Arnod pays 100% of employee contributions in terms of the rules of this fund. All employees are obliged to belong to the medical scheme. Approved remuneration amounts to R6 million. SARS approved the deduction. 1 200 000 9 022 000 5 Share incentive scheme During the 2012 financial year, Arnod implemented an executive share incentive scheme to promote the growth of the company and incentivise and retain its senior executives. The scheme was implemented with effect from 1 November 2011. On 1 November 2011, each of the five senior executives received 1 200 Arnod shares for no consideration in return for services to be rendered over the next five years. Arnod acquired the 6 000 shares in the market at a cost of R250 per share. During this five-year period, the executives may not dispose of or otherwise encumber these shares. In the event that an executive leaves the employment of Arnod within this five-year period, other than due to death, disability or retirement, the executive must sell the shares to Arnod at R250 per share. In the event of death, disability or retirement all restrictions on the shares will be lifted. The market value of Arnod shares at the date of Mr Bosch’s death was R265 per share. 5 6 Acquisition of office block Arnod acquired an office block from a trading trust, which is not a connected person in relation to Arnod, for R75 million on 29 February 2012. Arnod financed the acquisition by issuing 250 000 new equity shares to the trust. The trust is a registered VAT vendor and only makes taxable supplies. It held the office block as a capital asset. The sale qualified as the sale of a going concern. Arnod uses the office block wholly to make taxable supplies. The base cost of the office block to the trading trust was R42 million. No tax allowances were allowed on the building because the trading trust acquired the new office block prior to 1 April 2007. The market value of Arnod shares immediately prior to the transaction was R300 per share and on 1 March 2012 the market value was R320 per share. The market value of the office block at 28 February 2013 was R83 million. 7 SARS query After submitting the IT14 return, Arnod received a request for further information (an IT14SD) from SARS. SARS wants the company to pay VAT of R5 600 000, based on total rental income of R40 million. The total output VAT declared per the VAT201 forms for the year was R5 041 326,31.