Reference no: EM13490236

QUESTION

You are a tax manager in an accounting firm, and you have received some tax queries from one of your main clients.

The client, Vision Manufacturing Limited (‘Vision'), is a South African resident company, and its business is the manufacture of ceramic tiles. Vision has a December year end, and is a registered category C VAT vendor.

The company was incorporated in 1985 by Mr Thembelani Jacobs, and has its main manufacturing operations in Cape Town. Thembelani retired in 2002, after which the running of Vision was taken over by his daughter, Ms Cynthia Jacobs-Mthethwa.

On 25 October 2011 Cynthia died in a motor vehicle accident. It was subsequently agreed that her brother, Mr Angus Jacobs, would take over the running of Vision on 1 March 2012.

The following information is relevant to the queries you have received from the company: 1 During its 2011 year of assessment, Vision had four ‘registered learnerships' in respect of employees not previously employed:

· Two employees were registered for 30-month apprenticeships. The first employee started on 1 October 2008 with an annual salary of R102 000 and successfully completed his learnership on 31 March 2011. The second started on 1 October 2009 with an annual salary of R120 000, and is expected to successfully complete his learnership on 31 March 2012.

· Two employees successfully completed nine-month learnerships during the course of the year. The first employee started on 1 October 2010 and successfully completed her learnership on 30 June 2011, and the second (a disabled person) started on 1 January 2011 and successfully completed his learnership on 30 September 2011. Their annual salaries were R192 000 and R210 000 respectively.

2 On 1 January 2011 Vision acquired 100% of the shares of a company called Tilehouse Marketing & Distribution Proprietary Limited (‘Tilehouse').

· Tilehouse is a South African resident company, and the company's business is the wholesale distribution of all types of wall and floor tiles (such as ceramic, clay and porcelain tiles). Tilehouse had for many years been one of Vision's main customers, but the Vision management was never fully satisfied with Tilehouse's approach to the wholesale and construction market. Vision's purpose in acquiring Tilehouse was to increase the latter's focus on the ceramic tile business and in the process increase Vision's production and sales (to Tilehouse) of ceramic tiles.

· In order to finance the Tilehouse acquisition, Vision issued 100 000 debentures with a face value of R100 each at a discounted issue price of R98 each on 1 January 2011. The debenture terms require Vision to make a cash interest payment of R7,50 per debenture every eight months (that is, on 31 August 2011,

30 April 2012 and 31 December 2012). The debentures are to be redeemed on
31 December 2012 at a premium of R2 (thus redemption at R102 per debenture). This amount will be in addition to the R7,50 interest payment due on 6
31 December 2012. These cash flows represent a yield to maturity of 8,8994% per eight-monthly accrual period.
· In the light of Vision's very good trading results and cash flows for the year, the company repurchased 40 000 debentures on 30 November 2011, at a total cost of R3 870 000 (R96,75 per debenture). Assume that the debentures were issued for speculative purposes.

3 On 1 December 2011, Mr William Mthethwa (Cynthia's husband) sold 180 000 ordinary shares in Vision to Angus. Even though the shares had a market value of R21 600 000 (calculated at R120 per share) on 1 December 2011, the two parties agreed on a sale price of R18 million (R100 per share).

· William had purchased 50 000 Vision shares from an unrelated third party for R3 750 000 (R75 per share) in April 2005.
· William inherited the other 130 000 shares from Cynthia. She had acquired the 130 000 shares as follows:
- She inherited 100 000 ordinary Vision shares from her father, Thembelani, when he died on 20 July 2003 (and the market value was R68 per share).

The cost of the shares to him was R100 000, which was the issue price of R1 per share upon Vision's incorporation in March 1985.
- In addition, Vision had awarded Cynthia 30 000 options on 1 March 2007 for the acquisition of 30 000 shares at R80 per share, on condition that she would not sell the shares within the first 24 months of acquiring them. She exercised 20 000 options on 1 March 2008 and 10 000 options on 1 March 2009. She never sold any of these shares.

· As a result of this share transaction, Angus became the sole shareholder of Vision.

· The market values of the Vision shares were as follows on the relevant dates:

Date Market value
1 October 2001 R50 per share
20 July 2003 R68 per share
1 March 2007 R80 per share
1 March 2008 R95 per share
1 March 2009 R88 per share
1 March 2010 R96 per share
1 March 2011 R110 per share
25 October 2011 R125 per share
4 On 15 December 2011 Vision distributed a fixed property to Angus as a dividend in specie.
· The property had originally been acquired by Vision for R3 200 000 in 2006.

Vision never used the property itself but let it to an unrelated third-party tenant. In terms of the lease contract, the tenant was required to (and did) effect certain improvements. The improvements were completed at a cost of R1 100 000 during 2007, and this amount was included in Vision's gross income for its 2007 year of assessment. Vision did not claim a section 11(h) allowance.

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· The property had a market value of R5 600 000 on 15 December 2011 when it was distributed to Angus.

· From an accounting perspective, the distribution was fully funded out of available reserves. From a tax perspective, the Vision directors determined that the maximum possible amount of contributed tax capital would be returned as part of this distribution.

· At the end of Vision's financial year ended 31 December 2010, the company's share capital was R360 000 and its reserves were R35 million. Had the entirety of share capital been distributed to shareholders on 31 December 2010, R180 000 of the share capital would have constituted a ‘dividend' as defined in section 1 of the Income Tax Act, 1962 (Act 58 of 1962) on that date.

5 As part of Angus's remuneration package (from 1 March 2012), Vision expects to spend R14 000 per month on motor vehicle costs. It has two options in this regard:

(a) Vision acquires the motor vehicle in terms of a lease1 and grants the free use to Angus. The cash cost of the car is R456 000 (VAT inclusive). The lease payments on a three-year lease will be R14 000 per month, inclusive of VAT and maintenance; or

(b) Vision pays Angus a travel allowance of R14 000 per month. Angus then leases the vehicle on precisely the same terms as those outlined in (a) above. Angus will maintain an accurate logbook of kilometres travelled for business purposes. He expects to travel a total of some 28 000 km per annum, of which the private component is expected to be 21 000 km. The total cost of petrol for the private travel component is expected to be about R25 000 per annum, which Angus will pay himself.

All other costs, including the cost of petrol for the business travel component, will be covered by Vision.