l3 march 2014 q & a

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CHARTERED ACCOUNTANTS EXAMINATIONS _____________________

LICENTIATE LEVEL _____________________

L3: INTEGRATED TAXATION _____________________

THURSDAY 6 MARCH 2014 ____________________

TOTAL MARKS – 100 TIME ALLOWED: THREE (3) HOURS ____________________

INSTRUCTIONS TO CANDIDATES

1. You have fifteen (15) minutes reading time. Use it to study the examination papercarefully so that you understand what to do in each question. You will be told whento start writing.

2. This paper is divided into TWO sections:

Section A: Two Compulsory Questions.

Section B: Three Optional Questions. Attempt any two (2).

3. Enter your student number and your National Registration Card number on the fronof the answer booklet. Your name must NOT appear anywhere on your answerbooklet.

4. Do NOT write in pencil (except for graphs and diagrams).

5. The marks shown against the requirement(s) for each question should be taken asan indication of the expected length and depth of the answer.

6. All workings must be done in the answer booklet.

7. Present legible and tidy work.

8. Graph paper (if required) is provided at the end of the answer booklet.

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Taxation Table for March 2014 Examination

Income Tax

Standard personal income tax rates

Income band Taxable amount RateK1 to K26,400 first K26,400 0%K26,400 to 36,000 next K9,600 25%K36,000 to K70,800 next K34,800 30%Over K70,800 35%

Income from farming for individualsK1 to K26,400 first K26,400 0%Over K26,400 10%

GratuityK1 to K26,400 first K26,400 0%Over K26,400 25%

Terminal benefitsK1 to K35,000 first K35,000 0%Over K35,000 10%

Company Income Tax rates

On income from manufacturing and other 35%On income from farming 10%On income of Banks and other Financial Institutions 35%On income from mining operations 30%(Variable profit tax) y = 30% + [a - (ab/c)]Where: y = the tax rate to be applied per

annuma = 15%b = 8%c = Assessable Income x 100%

Gross sales

Capital Allowances

Implements, plant and machinery and commercial vehicles:Wear and Tear Allowance – Plant used normally 25%

Used in Manufacturing, Farming, Leasing 50%

Non- commercial vehiclesWear and Tear Allowance 20%

Industrial Buildings: Wear and Tear Allowance 5%

Initial Allowance 10%Investment Allowance 10%

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Low Cost Housing (Cost up to K20,000) Wear and Tear Allowance 10%Initial Allowance 10%

Commercial BuildingsWear and Tear Allowance 2%

Farming AllowancesDevelopment Allowance 10%Farm Works Allowance 100%Farm Improvement Allowance

100%

Presumptive TaxesTurnover Tax 3%

Presumptive tax for transporters

Seating capacity Tax perannum

Tax perday

K KLess than 12 passengers and taxis 600 1.60From 12 to 17 passengers 1,200 3.30From 18 to 21 passengers 2,400 6.60From 22 to 35 passengers 3,600 10.00From 36 to 49 passengers 4,800 13.00From 50 to 63 passengers 6,000 16.40From 64 passengers and over 7,200 19.70

Property Transfer Tax

Rate of Tax on Realised Value of property other than mining rights 5%Rate of Tax on Realised Value on a transfer or sale of a mining right 10%

Value Added Tax

Registration threshold K800,000Standard Value Added Tax Rate (on VAT exclusive turnover) 16%

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Customs and ExciseDuty rates on:

1. Motor cars and other motor vehicles (including station wagons)principally designed for the transport of less than ten persons,

including the driver:Customs Duty: 25%

Excise Duty: Cylinder capacity of 1500 cc and less 20% Cylinder Capacity of more than 1500 cc 30%

2. Pick-ups and trucks/lorries with gross weight not exceeding 20 tones:Customs Duty 15% Excise Duty 10%

3. Buses/coaches for the transport of more than ten personsCustoms Duty: 15% Excise Duty: Seating Capacity of 16 persons and less 25% Seating Capacity of 16 persons and more 0%

4. Trucks/lorries with gross weight exceeding 20 tonnesCustoms Duty: 15% Excise Duty:

0%

The minimum amount of Customs Duty on Motor Vehicles in categories from 1 up

to 3 above is K2,000

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SECTION A

Attempt both questions in this section.

QUESTION ONE

Alfred Mabula had been employed as an audiologist at HealthCare Hospital an institution

funded by international non-governmental organisations on a three year contract which

commenced on 1 June 2011. On 31 December 2012, he was declared redundant following

erratic funding to the hospital. He was paid his full benefits plus legal awards for the

premature termination of his contract.

Using his redundancy package and personal savings, Mabula set up his own practice and

started trading under the name of ‘Mabula Specialist Ear Clinic’ on 1 February 2013

preparing his first accounts to 31 December 2013 and annually thereafter. He leased

business premises on 1 February 2013 at K5,500, per month and purchased furniture and

fittings at a cost of K60,000 and equipment at a cost of K170,000. He hired five clinicpersonnel and purchased a motor car at a cost of K80,000, to be used both for business and

private purposes. He estimates his private use in the motor car to be 30%. His tax adjusted

business profits before capital allowances for the period to 31 December 2013 was

K1,650,000.

HealthCare Hospital engaged Alfred from 1 February 2013 as a self-employed contractor on

an eleven month contract ending on 31 December 2013. Under this contract, he was

required to report at HealthCare Hospital for three days a week, 6 hours per day. He

continued to occupy the office which he had used when he was an employee of HealthCare

Hospital. He also continued to use equipment and other facilities of the hospital when

attending to the hospital’s clients. In performing his duties at the institution, he was assistedby the hospital’s staff whenever necessary. He charged HealthCare Hospital an agreed

contract price of K132,000 payable in monthly instalments of K12,000. HealthCare Hospital

was to charge Mabula K3,000 per month as agreed payments for use of the hospital’s

facilities.

HealthCare Hospital was recently subjected to a Pay As You Earn tax audit and PAYE

inspectors from the Zambia Revenue Authority queried Mabula’s self -employed status in

respect of his contract with Healthcare Hospital.

Required:

(a) Discuss the criteria that will be used in determining whether Mabula will be classifiedas employed or self-employed in respect of his contract with HealthCare Hospital. Your answer should include an explanation of:

(i) Four (4) factors that led to the Zambia Revenue Authority’s Tax Auditors toquestion Mabula’s self -employed status. (4 marks)

(ii) Three (3) factors HealthCare Hospital and Mabula can put forward to justifyMabula’s self - employed status. (3 marks)

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(b) Assuming that Mabula is held to be an employee in relation to the contract he haswith Healthcare Hospital, compute his income tax payable for the tax year 2013.

(4 marks)

For the purpose of this part of the question you should assume that today’s date is 20

December 2013 and the earnings ceiling for the purposes of NAPSA contributions should betaken to be K160,715 per annum.

Lungowe Sikazwe who recently completed her course at the University of Zambia has been

offered two alternative offers of employment from two Zambian resident companies, Celcom

Zambia Limited and Zedcom plc. Regardless of which offer is chosen, she will commence

employment on 1 January 2013. The conditions of service under each offer of employment

are as follows:

Offer from Celcom Zambia Limited

Her annual salary will be K180,000. The company will rent an apartment on her behalf and

will pay annual rentals amounting to K54,000 for the apartment from 1 January 2013 and

annual utility expenses in connection with the apartment amounting to K12,000. The

company will also pay her monthly medical insurance premiums amounting to K600.

On 1 January 2013, she will be provided with a personal to holder motor car with a cylinder

capacity of 3000cc which the company will purchase at a cost of K90,000. Her business use

of the car is estimated to be 60%. The company will pay all the running costs associated

with the car which will amount to K30,000 per year. Lungowe will be required to pay K1,500

per month for use of the motor car.

She will contribute 5% of her basic salary as NAPSA contribution and Celcom Zambia Limited

will also contribute 5% of her basic salary as NAPSA contribution on her behalf.

Offer from Zedcom plc

Her annual salary will be K180,000. She will be accommodated in a company house

commencing from 1 January 2013, which has a market value of K550,000. If the house was

let out on a commercial basis, the company would have charged monthly rentals of K4,500.

The company will pay all expenses in connection with the house which will amount to

K12,000 per year.

From 1 January 2013, Lungowe will use her own personal motor car with a cylinder

capacity of 3000cc, which she will acquire at a cost of K90,000 for the duties of her

employment. The business use of the motor car is estimated to be 60%. She will incur total

annual motor car running expenses amounting to K30,000 which the company will refund to

her in full. She will pay annual medical insurance premiums of K6,000.

Under the offer from Zedcom plc, she will contribute 5% of her basic salary as NAPSA

contribution and Zedcom plc will also contribute 5% of her basic salary as NAPSA

contribution on her behalf.

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Required:

(c) Calculate Lungowe’s income tax payable for the tax year 2013 if she:

(i) Accepts the offer of employment from Celcom Zambia Limited. (4 marks)

(ii) Accepts the offer of employment from Zedcom plc. (4 marks)

(d) Advise Lungowe as to which offer is better from a taxation point of view. Youranswer should be supported by appropriate calculations of the total amount ofincome receivable and net income after tax for the tax year 2013, under eachalternative offer of employment. (6 marks)

(e) State the income tax implications for Celcom Zambia Limited and Zedcom plc arisingas a result of their offers of employment to Lungowe. (5 marks)

(Total: 30 marks)

QUESTION TWO

(a) Multinational companies operating in Zambia through subsidiaries such may use theirZambian resident subsidiaries to reduce the tax liabilities of the group as a whole byusing a wide range of practices. Such practices may include the following:

(i) A Zambian resident subsidiary obtaining excessive debt finance from foreignmembers of the group.

(ii) A Zambian resident subsidiary making cheap loans (low interest loans) toforeign members of the group.

(iii) Transfer pricing policies designed to reduce the tax liability of the group.

Required:

Describe how a Zambian resident subsidiary of a foreign multinational company mayuse each one of the above practices to reduce its tax liability and discuss how anti-avoidance tax legislation attempt to prevent such practices. (9 marks)

MNQ Zambia plc is a Zambian resident company engaged in the mining of copper inZambia. It is a 90% owned subsidiary of FNQ Mining International, a Canadian basedmultinational company engaged in mining activities in different parts of the world aswell as in the manufacture of ammunition and explosives. The group maintains its

accounts in the United States dollars. The following summarised statement of profitor loss has been extracted from the financial statements of MNQ Zambia plc.

MNQ ZAMBIA PLC

INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2013

K

Revenue 11,744,000

Cost of sales (5,344,000)

Gross profit 6,400,000

Operating expenses (3,990,000)

Other income 70,000Profit before interest and tax 2,480,000

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Interest paid (600,000)

Profit before tax 1,880,000

Income tax expense (593,000)

Profit for the period 1,287,000

The following additional information is available:

1. The figure for revenue in the income statement represents the gross sales ofcopper based on the average London Metal Exchange copper price per metrictonne.

2. The depreciation charge for the year included in cost of sales was K115,000.

3. Included in operating expenses is capital expenditure which accounts for 40%of the total operating expenses. 10% of this capital expenditure does notqualify for any tax relief and the remainder is only eligible for tax relief at the

rate of 25% as mining capital expenditure.

4. Income generated from hedging foreign currency transactions during the taxyear 2013 amounted to K50,000. This has been included in the incomestatement shown above under other income. There were no hedging lossesbrought forward at 1 January 2013.

5. Also included in other income is loan note interest received amounting toK8,000 (gross) and dividend income of K12,000 (gross) from non-miningcompanies listed on the Lusaka Stock Exchange.

6. The company has debt: Equity ratio of 11:2.

7. The income tax values of imported mining equipment at 1 January 2013 wasK262,500. The equipment was acquired in the tax year 2012 at a cost ofK350,000. All other implements, plant and machinery qualifying for capitalallowances were completely written down to zero at 1 January 2013.

8. The income tax expense in the income statement represents the provisionalincome tax paid by the company in the tax year 2013.

9. Mineral royalty paid during the year has not been accounted for in the incomestatement shown above.

10.

The company has had the following results in the past three years.

Year ended 31 December 2010 2011 2012

K K K

Sales 4,697,600 5872,000 9,395,200Tax adjusted miningprofits/(losses) (1,750,000) 644,000 1,005,350

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11. The following exchange rates have been provided by the Bank of Zambia andapproved by the Commissioner General:

Date ZMW/ US Dollar rate

31 December 2010 4.00

31 December 2011 4.6031 December 2012 5.06

31 December 2013 5.56

12. The indexation formula is provided below:

1 + –

R 1

Required:

(b) Show how the mining loss incurred in the year ended 31 December2010 will be relieved in each of the relevant years and state theamount of any loss remaining unrelieved at 31 December 2012.

(6 marks)

(c) Compute the taxable business profit for MNQ Zambia plc for the tax

year 2013. (10 marks)

(d) Compute the total taxes paid by MNQ Zambia plc in the tax year 2013.

(5 marks)

(Total: 30 marks)

SECTION B

Attempt any TWO (2) out of the THREE (3) questions in this section.

QUESTION THREE

(a) In the context of tax audits and investigations explain, giving examples, the meaningof the following types of defaults that may be discovered during a tax audit.

(i) Deliberate behaviour (2marks)

(ii)

Careless behaviour with significant consequences (2 marks)(iii) Careless behaviour without significant consequences (2 marks)

(b) For the purpose of this part of the question assume that today’s date is 1June 2013.

Monde Chimuka who recently completed a course in entrepreneurship intends tocommence business on 1 September 2013, selling computer accessories andstationery. He plans to purchase, shop fittings at a cost of K60,000 (VAT exclusive),computers at a cost of K25,000 (VAT exclusive) and a motor car at a cost of K95,000(VAT inclusive) on 30 July 2013. He estimates that his private use in the motor carwill be 40%.

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He will lease business premises on 1 September 2013 at K4,500 per month (VATexclusive) and will commence trading on the same date preparing his first accountsto 31 December 2013 and annually thereafter.

He expects his VAT exclusive sales, and VAT exclusive standard rated purchases and

business expenses (including lease rentals) for the first four months to 31 December2013 to be as follows:

September October November December

K K K K

Sales 62,000 85,000 110,000 135,000

Purchases and business expenses 27,200 41,000 56,000 71,000

(Including lease rentals)

From January 2014 he expects his VAT exclusive sales to average K175,000 permonth, while VAT exclusive standard rated purchases and business expenses

including lease rentals will average K97,600 per month. Monde does not have anyother sources of income apart from this proposed business. He is not sure as towhether he will be required to register for Value Added Tax in respect of thisbusiness and has approached you for advice.

Required:

(i) Write a letter advising Monde of the Value Added Tax (VAT) registrationrequirements and how these will be applied to his proposed business todetermine whether or not he will be required to register for VAT. You shouldfurther advise Monde as to whether he will be able to claim any input VAT on

the capital assets he will acquire on 30 July 2013 once he registers for VAT. (9 marks)

(ii) Assuming Monde registers for Value Added Tax in respect of his proposedbusiness with effect from 1 September 2013 and assuming that he had noother income in the tax year 2013, calculate his income tax payable for thetax year 2013. (5 marks)

(Total: 20 marks)

QUESTION FOUR

(a) Distinguish inward investment from outward investment and explain the taxtreatment of each of these types of foreign direct investment. (4 marks)

(b) BGH Limited a newly established company which registered for Value Added Taxunder the voluntary VAT registration provisions is considering investing in themanufacturing sector. The company is planning to set up a production factory to beused in the manufacture of detergent soaps. The directors of the company areconsidering the following acquisition options for the production factory.

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Option 1

Purchase an existing second hand factory at an estimated cost of K1,995,200including Value Added Tax from a VAT registered vendor on 1 January 2013, whichwill be brought into use on that date.

Option 2

Contract a local construction company to construct the production factory building ata total cost of K4,168,000 which will be made up of the following items:

Construction is expected to be completed by 1 January 2013 and the factory will

immediately be brought into use.

Option 3

The company can obtain a medium sized factory on an arranged lease for 20 yearsstarting on 1 January 2013. This arrangement will entail a monthly rental of K20,000excluding VAT and the lease premium will be K200,000 excluding VAT.

The directors have approached you to provide an outline of the taxation implicationassociated with each option being considered before a final decision can be made.

Required:

Advise the directors of BGH Limited of the Income Tax and Value Added Taximplications of each of the above options being considered for the production

factory. (16 marks)(Total: 20 marks)

QUESTION FIVE

For the purpose of this question, you should assume that today’ s date is20December 2013 and the earnings ceiling for the purposes of NAPSAcontributions should be taken to be K160,715 per annum.

Mwiza and Lukonde set up an unquoted trading company known as Mwiko Limited twoyears ago preparing accounts to 31 December each year. Mwiza and Lukonde each own50% of the issued ordinary share capital of the company. Mwiza is both a director and isemployed by Mwiko Limited whereas Lukonde is neither an employee nor a director of this

K

Cost of land 1,500,000

Ventilation and heating system 130,000

Staff facilities 350,000

Quality control facilities 120,000

Factory 1,250,000

General offices 450,000

VAT on building materials 368,000

4,168,000

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company. Mwiza has always drawn an annual salary of K350,000 and this also applies tothe year ending 31 December 2013. The company has had an exceptionally successful yearfor the period ending 31 December 2013.

Throughout the tax year 2013, Mwiza and Lukonde were provided with new motor cars

acquired by Mwiko Limited on 1 January at a cost of K120,000 each. Both cars use petroland each car has a cylinder capacity of 3000cc. The company additionally paid for fuel forthe two motor cars which amounted to K18,000 for Mwiza and K12,000 for Lukonde. Mwizais accommodated in a company house which was acquired by Mwiko Limited on 1 January2013 at a cost of K650,000. Lukonde rents her own apartment and in the tax year 2013, thecompany paid annual rentals amounting to K78,000 in relation to the apartment on herbehalf.

On 31 December 2013, Lukonde was additionally provided with an interest free loan ofK650,000 by Mwiko Limited which is repayable in two years’ time to enable her purchaseher own house.

Lukonde and Mwiza have agreed that in view of the exceptional performance of thecompany in the year ending 31 December 2013, Mwiza should in addition to her normalannual salary be given a lump sum payment of K150,000 on 31 December 2013. They wouldlike this additional lump sum payment to take the form of either a cash bonus payment or adividend payment but are not sure of the taxation implications associated with each option.

Required:

(a) Advise Mwiza and Lukonde of the taxation implications for both themselvesindividually and for Mwiko Limited arising from:

(i)

The provision of motor cars to Mwiza and Lukonde. (6 marks)(ii) The provision of accommodation to Mwiza and payment of rentals for

Lukonde’s apartment. (3 marks)(iii) Provision of an interest free loan to Lukonde. (3 marks)

Your answer in each case must be supported by appropriate calculations ofadditional income tax payable or the reduction in income tax payable.

(b) Using appropriate calculations, show the income tax and NAPSA implications for bothMwiza individually and for Mwiko Limited if the additional lump sum payment of

K150,000 were to take the form of:

(i) A cash bonus payment ( 4 marks)

(ii) Dividend payment (4 marks)

(Total: 20 marks)

END OF PAPER

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L3: INTEGRATED TAX SUGGESTED SOLUTIONS

L3: INTEGRATED TAX

SUGGESTED SOLUTIONS

MARCH 2014

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SOLUTION ONE

(a) (i) The primary test used to identify whether employment exist is to determine

whether the type of contract in question constitutes a contract of service

which indicates employment, or a contract for services which indicates self-employment. However, the distinction is not always easy to make andtherefore additional factors are also considered in determining whether or notthere is employment.

In the particular circumstances of the contract between Mabula andHealthCare Hospital the following factors may have led the ZRA to query hisself-employed status:

1. It seems that Healthcare Hospital has control over when and howmany times Mabula has to report for work at the institution, that isthree days a week for 6 hours each day.

An employee is controlled by the employer who will normally stipulatethe working hours, the place at which duties are to be performed andother such conditions.

2. In the performance of his duties at HealthCare Hospital, Mabula usesthe equipment and facilities of the Hospital and is additionally assistedby hospital staff whenever necessary.

This indicates employment, as employees are normally provided withtools and equipment by their employer.

3. It appears that Mabula has to perform the duties at HealthcareHospital personally and cannot use other people or use his own clinicstaff to help him perform those duties.

4. Mabula has to attend to the hospital’s patients at the premises ofHealthCare Hospital and does not have the liberty to attend to thosepatients at his own clinic or any other place he may choose.

Employees work under such conditions as they are normally toldwhere to perform their duties which is normally their employer’spremises.

5. Mabula had recently been an employee of Healthcare Hospital and itcould be that an agreement had been reached to let Mabula tocontinue working for the institution whilst also running his own privateclinic.(1 mark for each valid point up to a maximum of 4 marks)

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(ii) Factors HealthCare Hospital and Mabula may use to justify his self-employed status.

1. Mabula does not does not exclusively work for HealthCareHospital. He spends part of his time attending to his own patients

at his own clinic.

2. Mabula is engaged on a contract with a specified limited durationwhich runs from 1 February 2013 to 31 December 2013. Thereappears to be no assurance that the contract will be renewed onceit expires. Self-employed individuals work under such conditions.

Employees on the other hand sign a contract with the employerwhere the employer has the right to terminate the contract aftergiving the employees an appropriate period of notice. Clearly thisis not the case in the circumstances of the contract Mabula haswith HealthCare Hospital.

3. Mabula is paid an agreed contract price even though it is paid inmonthly instalments. Additionally he is not entitled to any otherbenefits associated with employment such as leave pay, sickleave, pension rights or gratuity on expiry of the contract etc.

4. Although he uses Healthcare Hospital’s equipment and otherfacilities when performing his duties of employment, the institutioncharges a fee of K3,000 for use of those facilities.

An employee is not normally charged a fee for use of the

employer’s equipment and facilities. (1 mark for each valid point up to a maximum of 3 marks)

(b) MABULA

PERSONAL INCOME TAX COMPUTATION FOR THE TAX YEAR 2013

K K

Emoluments from employment

Salary 132,000 ½

Less payment for use of facilities (33,000) ½

Assessable emoluments 99,000

Business profits

Profit before capital allowances 1,650,000 ½

Less capital allowances on:

- Furniture (K60,000 x 25%) (15,000) ½

- Equipment (K170,000 x 25%) (42,500) ½

- Motor car (K80,000 x 20%) (16,000) ½

1,576,500

1,675,500

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Income tax

K70,800 12,840 ½

K1,604,700 x 35% 561,645 ½

574,485

(c) (i) OFFER FROM CELCOM (Z) LIMITED

(ii) OFFER FROM ZEDCOM PLC

K

Annual salary 180,000 ½

Rentals for apartment 54,000 ½

Utility expenses 12,000 ½

Medical insurance (K600 x 12) 7,200 ½

Gross income 253,200

Less:

Motor car expenses (K1,500 x 12) x 60% (10,800) ½

NAPSA contribution (restricted to maximum) (3,060) ½239,340

Income tax

K70,800 12,840 ½

K168,540 x 35% 58,989 ½

71,829

K

Annual salary 180,000 ½

Refund of motor car expenses 30,000 ½

Utility expenses 12,000 ½

Gross income 222,000

Less:

Motor car expenses (K30,000 x 60%) (18,000) ½

NAPSA contribution (restricted to maximum) (3,060) ½

Capital allowances (K90,000 x 20%) x 60% (10,800) ½

190,140Income tax

K70,800 12,840 ½

K119,340 x 35% 41,769 ½

54,309

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(d) COMPUTATION OF NET INCOME UNDER EACH OFFER OF EMPLOYMENT

OFFER FROM CELCOM (Z) LIMITED

OFFER FROM ZEDCOM PLC

The offer from Celcom (Z) limited is more beneficial as it gives a higher net incomeafter all deductions. ½

(c) Tax implications for Celcom Zambia Limited

1. The annual salary, rentals for apartment, utility expenses and medical insurancepaid by the company will be allowable when computing taxable business profits.

2.

Motor car running expenses incurred in connection with the car provided toLungowe will be deductible when computing taxable profits.

3. Provision of a personal motor car will give rise to a taxable benefit on thecompany. The car provided has a cylinder capacity of 3000cc and therefore andK20,000 will be disallowed when computing the taxable business profit for thebusiness.

4. The company will be able to claim capital allowances at the rate of 20% on thecost of the motor car.

K

Annual salary 180,000

Rentals for apartment 54,000Utility expenses 12,000

Medical insurance (K600 x 12) 7,200

Gross income 253,200 1

Less:

Motor car expenses (K1,500 x12) (18,000) ½

NAPSA 5% x 160,715 (8,036) ½

Income tax payable (71,829) ½

Net income 155,335

K

Annual salary 180,000

Refund of motor car expenses 30,000

Utility expenses 12,000

Gross income 222,000 1

Less:

Motor car expenses (30,000) ½

Medical insurance (6,000) ½

NAPSA 5% x 160,715 (8,036) ½

Income tax payable (54,309) ½

Net income 123,655

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5. The NAPSA contribution made on behalf of Lungowe will be allowable whencomputing taxable business profits.

6. The amount paid by Lungowe to the company of K1,500 per month will betaxable on the company.

(½ a mark for each valid point stated up to a maximum of 2½ marks)

Tax implications for Zedcom plc

1. The annual salary and utility expenses in connection with accommodation will beallowable when computing taxable business profits.

2. The refund of motor car expenses by the company will be allowable whencomputing taxable business employer’s

3. NAPSA contribution paid by the company on behalf of Lungowe will be anallowable deduction when computing taxable profit.

4.

Provision company accommodation will give rise to a taxable benefit on thecompany calculated as 30% of Lungowe’s assessable emoluments.

5. No assessable benefit will arise on use of Lungowe personal for businesspurposes, neither will capital allowances be claimable by the company on the car.

(½ a mark for each valid point stated up to a maximum of 2½ marks)

SOLUTION TWO

(a) (i) Excessive debt finance from foreign members of the group

Multinational companies such are motivated to finance their foreignsubsidiaries through loans rather than share capital because in many jurisdictions including Zambia, interest paid on loan finance is allowable,whereas, dividends paid to equity providers are not. As a result, when aZambian resident subsidiary of a foreign multinational is heavily financed bydebt obtained from foreign members of the group, its taxable profit will besubstantially reduced by interest payments made on such loans.

To prevent huge reductions of taxable profit by way of interest deductions,thin capitalisation rules are put in place. These rules limit the amount ofinterest that would be allowed as a deduction when computing taxable

business profits. This is done by not allowing as an expense, the amount ofinterest paid when the company’s debt equity ratio exceeds a certain limit.

In Zambia, some mining companies are subsidiaries of foreign companies.These foreign companies may finance the subsidiaries through high level ofdebt. Interest on such loans will only be allowable as an expense when thedebt equity ratio does not exceed the ratio 3:1. When the amount of debtobtained results in this ratio being exceeded, then interest on the excess debtis not an allowable deduction.

(1 mark for each valid point up to a maximum of 3 marks)

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(ii) Cheap loans to foreign members of the group

Making loans at an interest rate which is lower than the commercial rate has

the effect of reducing the taxable profits for the company receiving theinterest. This is because the taxable profits will be lower than they should

have been if the higher interest or commercial rate had been used.

A Zambian resident subsidiary can therefore substantially reduce its tax

liabilities by making loans to foreign members of the group and charging a

reduced rate of interest on such loans.

When a Zambian resident company makes a loan to a foreign related

company, it must charge interest on such a loan at a commercial rate. When

the interest rate charged on such a loan is less than the commercial rate, the

company receiving the interest is deemed to have received the interest at the

commercial rate.


(iii) Transfer pricing policies

Multinational companies may produce goods in one country which are thentransferred for sale to other countries. The price at which such goods aretransferred from the country where they are produced to the country inwhich they are sold is a transfer price. Multinational companies may

manipulate the transfer price so that profits arise in a country where the ratesof taxation are lower so that the overall tax position of the group isminimised.

A Zambian resident subsidiary may therefore transfer or sale goods to aforeign member of the group at a price which is lower than the market valueof those goods therefore reducing the taxable profit of the Zambian residentcompany. This will normally be in a situation where the tax rates that apply inthe country in which the foreign company operates are lower than thoseapplying to the Zambian resident company.

Anti-avoidance legislation attempts to prevent a company from transferringgoods out of the country at a price which is lower than the market price ofthose goods. As such, when a Zambian company is required to transfer goodsproduced in Zambia to a company that is resident abroad, then the transferprice should be equal to at least, the market value of the goods. When thetransfer price is lower than the actual market value of the the goods beingtransferred, then the profit element must be added when computing taxableprofits.


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(b) COMPUTATION OF LOSS RELIEF

2010 2,011 2012

K K K

Tax adjusted mining profits Nil 644,000 1,005,350 1Loss relief (W) Nil (644,000) 1,005,350 1

Taxable profits Nil Nil Nil

Loss relief in 2011

Indexed loss b/f

K1,750,000 x [1+ ((4.60 - 4.00)/4.00))] 2,012,500 1

Amount of loss relieved in year ended 31 December 2011 (644,000) ½

Unrelieved loss c/f at 31 December 2011 1,368,500 ½

Loss relief in 2012Indexed loss b/f

K1,368,500 x [1+ ((5.06 - 4.60)/4.60))] 1,505,350 1

Amount of loss relieved in year ended 31 December 2012 (1,005,350) ½

Unrelieved loss c/f at 31 December 2012 500,000 ½

(c) COMPUTATION OF TAXABLE BUSINESS PROFITS

K K

Profit before tax 1,880,000 ½

AddDepreciation 115,000 ½

Disallowed capital expenditure in operating expenses 1

(40% x K3,990,000 = K1,596,000 x 10%) 159,600

Excess deduction on qualifying mining expenditure

included in operating (30% x K1,596,000 ) x 75% 359,100 1

Disallowed excessive interest

(2.5/3 x K600,000) 500,000 1

1,133,700

Less 3,013,700

Mineral royalty (6%x K11,744,0000) 704,640 1Indexed capital allowances

(25% x K350,000) = K87,500 x [1+ ((5.56 – 5.06)/5.06))] 96,146 2

Loan note interest received 8,000 ½

Dividends received 12,000 ½

820,786

2,192,914

Less indexed loss K500,000 x [1+ ((5.56 – 5.06)/5.06))] (549,407) 1

Tax adjusted mining profit 1,643,507

Interest income 8,000 1

Taxable business profits 1,651,507

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(d) COMPUTATION OF TOTAL INCOME TAX PAYABLE

Mineral royalty 704,640 ½

Company income tax on interest income (K8,000 x 35%) 2,800 1Company income tax on mining profit( K1,643,507 x 36.43%(W)) 598,730 2

1,306,170

Less

WHT- on loan interest (15% x K8,000) (1,200) ½

Provisional income tax (593,000) ½

711,970 ½

Workings

1.

Assessable mining profit as a percentage of sales:

K1643,507/11,744,000 x 100%

= 14%

2. The variable profit tax rate will therefore apply:

y = 30% + [a - (ab/c)]

= 30 + [15 - (15 x 8/14)]

= 36.43%

SOLUTION THREE

(a) (i) Deliberate behaviour

This refers to breach of tax obligations/ regulations where there is intent onthe part of the tax payer.

Examples include failure to maintain books and records, omissions oftransactions from books, providing false or misleading information etc.

(2 marks)

(ii) Careless behaviour with significant consequences

This refers to a failure by a tax payer to take reasonable care in meeting taxobligations or complying with tax regulations resulting in a significant amountof tax being underpaid with reference to the correct amount of tax thatshould have been paid for the relevant period.

Examples include neglecting to categorise expenditure into allowable anddisallowable types for taxation purposes. (2 marks)

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(iii) Careless behaviour without significant consequences

This refers to a failure by a tax payer to take reasonable care in meeting tax

obligations or complying with tax regulations. However the amount of tax

underpaid in this case is not significant when compared to the amount of tax

liability due for that relevant period.

Examples include computational errors and inadequate adjustments for

personal expenditure in the profit or loss account. (2 marks)

(b) (i) Tax Consultant

P O Box 1000

LUSAKA

1 June 2013

Monde ChimukaP O Box 2000

NDOLA

Dear Monde

VAT REGISTRATION REQUIREMENTS

I am writing to explain to you the Value Added Tax (VAT) registration mattersrelating to the business you plan to start and other aspects of VAT which willbe relevant to your business.

VAT Registration

VAT registration is compulsory once the VAT exclusive value of taxablesupplies exceed K800,000 for any period of twelve months or K200,000 forany period of three months. These figures are based on the value ofcumulative taxable supplies in the previous twelve months ,or three monthsas the case may be.

You will have the obligation to inform the ZRA within 30 days of the end ofthe month in which the limit is exceeded. Registration will become effectiveon the first day of the following month.

VAT registration is also required if there is reasonable grounds to believe thatthe taxable supplies in the following twelve months will exceed K800,000 orfor the following three months to exceed K200,000.

Based on the estimates of your taxable supplies, the sales of the businesswill be as follows:

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The annual VAT registration threshold will therefore be exceeded in March2014, when the cumulative turnover will be K917,000. You will therefore berequired to inform the ZRA by the end of April 2014. Your registration will beeffective as of 1 May 2014 or an agreed earlier date.

Alternatively the quarterly VAT registration threshold of K200,000 will beexceeded in in November 2013, when the cumulative turnover for a periodof three months will be will be K257,000. In this case the ZRA will have to benotified by the end of December 2013.

You also have an option of voluntary registration prior to the above dates, inwhich case you will normally become registered from the date you applied forregistration. This is quite useful where your sales are to VAT registeredcustomers for whom the extra VAT would not be a cost. You would then berequired to recover input VAT on your expenses. You will however have tocomply with VAT administrative requirements.

Recovery of input VAT

Pre-registration input VAT can be recovered provided that the VAT wasincurred within three months prior to the effective date of registration andthe goods are still in stock on the effective registration date. You thereforehave 3 months from the effective registration date to recover VAT on thefixture and fittings and computers. VAT incurred on motor cars isirrecoverable and therefore you will not able to recover VAT incurred on themotor.

You must therefore apply for voluntary registration as soon as possible

because registering after 31 October 2013 will mean that you will not be ableto recover the input VAT on the fixtures and fitting and computer.

I hope the information I have provided will be helpful.

Yours sincerely

A Consultant

(1 mark for each relevant valid point up to a maximum of 7 marks plus up to2 marks for structure and presentation of the letter giving a total of 9 marks)

Month Monthly sales Cumulative sales

K K

September 2013 62,000 62,000

October 2013 85,000 147,000

November 2013 110,000 257,000

December 2013 135,000 392,000

January 2014 175,000 567,000

February 2014 175,000 742,000

March 2014 175,000 917,000

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(c) COMPUTATION OF INCOME TAX PAYABLE

K

Revenue (K62,000 +K85,000 + 110,000 + 135,000) 392,000 1

Purchases (K27,000 + K41,000 + K56,000 +71,000) (195,000) 1

Less allowable deductionsCapital allowances

- on computers 25%x K25,000 (6,250) ½

- Motor car (20% x K95,000) x 60% (11,400) ½

- Shop fittings (25%x K60,000) (15,000) ½

Taxable business profits 164,350

Income tax

K70,800 12,440 ½

K93,350 x 35% 32,743 ½

45,183 ½

SOLUTION FOUR

(a) Inward Investment

Inward investment is the foreign direct investment a foreign enterprise makes whenthat entity invests in Zambia. (1 mark)

When a foreign enterprise invests in Zambia, it is liable to Zambian income tax if theentity sets up a permanent establishment in Zambia. The whole amount of profitsarising from the operations of the permanent establishment would then be liable to

Zambian income tax subject to any double taxation relief which may be availableunder double taxation conventions. (1 mark)

Outward Investment

Outward investment on the other hand is the foreign direct investment which occurswhen a Zambian enterprise makes an investment in a foreign country. (1 mark)

A Zambian resident taxable person making an investment abroad is liable to Zambiaincome tax on any income generated from the foreign investment as long as theperson remains resident in Zambia. The amount of income taxable on the foreign

investment will be subject to any double taxation relief which may be available underdouble taxation agreements. (1 mark)

(b) Option 1-Purchase an existing second hand factory

The tax implications will be:

1. The company will be able to claim input VAT on the cost of the factory. Theamount of the recoverable input VAT will be;

K1,995,200 x 4/29 = K275,200 (1 mark)

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2. The company will be able to claim industrial buildings allowances at the rate of5% on the VAT exclusive cost of the building. The annual wear and tearallowance which will be given as an allowable deduction when computing taxablebusiness profits will amount to:

5% x (K1,955,200 x 25/29) = K1,651,200 (1 mark)

3. Under this option the 10% initial allowance and the 10% investment allowancewill not be available as these allowances are only available on new buildings upontheir first construction. (1 mark)

Option 2-Construct factory

The tax implications will be:

1. The company will be able to claim recovery of input VAT on the buildingmaterials which will amount to K368,000. (1 mark)

2.

If a contractor is hired to construct the factory, the factory will be new andwill be brought will be brought into business use for the first time afterconstruction and will therefore qualify for the initial allowance at the rate of10%, the investment allowance at the rate of 10% and the annual wear andtear allowance at the rate of 5% on the qualifying expenditure.

The qualifying expenditure will be calculated as follows:

K

Total construction cost 4,168,000

Less

Cost of land (1,500,000) ½ Ventilation and heating system (130,000) ½

VAT on building materials (368,000) ½

2,170,000

10% x K2,170,000 = K217,000

Since the cost attributed to the general offices of K450,000 exceeds this amount,

it will not be treated as part of the qualifying cost for industrial building

allowances purposes. The qualifying cost will therefore be:

K2,170,000 – K450,000 = K1,720,000 (1 mark)

The general offices will instead qualify for annual wear and tear allowances atthe rate of 2% as commercial buildings. The allowance will be given as allowable

deduction when computing taxable business profits and will amount to:

2% x K450,000 = K9,000 (1 mark)

3. The staff facilities, quality control facilities, and factory will each rank for the

initial allowance at the rate of 10%, the investment allowance at the rate of 10%

and the annual wear and tear allowance at the rate of 5% as qualifying

expenditure. The initial allowance and investment allowance will only be available

in the first year the building is brought into use.

The allowances which will be given as allowable deductions when computing

taxable business profits on each structure will be computed as follows:

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4. Expenditure on the ventilation and heating system will qualify for annual wear

and tear allowances at the rate of 25% as expenditure on implements plant and

machinery which will be given as allowable deductions when computing taxable

business profits.

The amount of the annual wear and tear allowance will be:

25% x K130,000 = K32,500 (1 mark)

Option 3-Lease factory

The implications will be:

1. The company will be able to claim input VAT on the lease rental. (1 mark)

2. The lease rentals will be given as allowable deductions when computing thetaxable business profits. The total allowable deductions claimable in the taxyear 2013 will therefore be:

K20,000 x 12 = K240,000

The company will however, not be able to claim capital allowances on thebuilding, instead the owner of the factory will claim the allowances as the title ofownership will remain with the lessor. (1 mark)

3. The proportion of the of the premium assessed as income on the owner willadditionally be an allowable deduction over the lease term and will becomputed as follows;

P- [2%x P (n-1)]

[K200,000 – (K200,000 x 2% x (20-1)) = K124,000

K124,000/20 = K6,200 per annum

(1 mark)

K

Staff facilities

Initial allowance (10% x K350,000) 35,000 ½

Investment allowance (10% x K350,000) 35,000 ½

Wear and tear allowance( 5% x K350,000) 17,500 ½

87,500

Quality control facilities

Initial allowance (10% x K120,000) 12,000 ½

Investment allowance (10% x K120,000) 12,000 ½

Wear and tear allowance( 5% x K120,000) 6,500½

30,500

Factory

Initial allowance (10% x K1,250,000) 125,000 ½

Investment allowance (10% x K1,250,000) 125,000 ½

Wear and tear allowance( 5% x K1,250,000) 62,500 ½

312,500

Total Allowances 430,500

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SOLUTION FIVE

(a) (i) Tax implications:

Provision of motor car to Mwiza:

Implications for Mwiko Limited:

1. Mwiko limited will be assessed to income tax on the car depending on thecylinder capacity of the car. As the cylinder capacity of the car is 3000ccthe annual taxable benefit assessed on the company will be K20,000.

(1 mark)2. The company will be able to claim capital allowances on the car at the

rate of 20% which will be an allowable deduction when computingtaxable business profits. The capital allowance will amount to:

20% x K120,0000 = K24,000 (1mark)

3. The company will also be able to claim as an allowable deduction the fuelexpenses incurred on the car.

4. As the result of providing the car to Mwiza the additional tax payable bythe company will be:

The net company income tax saving as result will therefore be:

35% x K16,000 = K5,600 (1 mark)

Implications for Mwiza:

There will be no implications for Mwiza in respect of the car provided for heruse.

Provision of motor car to Lukonde:

1. The provision of a motor car to Lukonde who is not a director or anemployee of Mwiza Limited will be treated as a payment of a dividend tothe shareholder as Lukonde is an effective shareholder in Mwiko Limited. (1 mark)

2. The company will not be able to claim any capital allowances on themotor car used by Lukonde as the car will not have been in business use.

(1 mark)

K

Motor car benefit 20,000

Capital allowance (24,000)

Fuel expenses (12,000)

Reduction in taxable profit 16,000

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3. The company will be required to pay tax on the fuel expenses paid onLukonde’s car. The amount of income tax will be:

35/65 x K8,000 = K4,308 (1 mark)

(ii) Tax implications of the provision of accommodation to Mwiza.

1. Provision of free residential accommodation will give rise to a taxablebenefit of 30% of Mwiza’s taxable emoluments on the company which willbe added back when computing taxable profits resulting in additional taxbeing paid on the amount by the company.

2. There will be no tax implications for Mwiza. (1 mark)

Tax implications of the rentals for Lukonde’s apartment

1. The payment of rentals for Lukonde who is not a director or an employee

of Mwiza Limited will be treated as a payment of a dividend to theshareholder as Lukonde is an effective shareholder in Mwiko Limited.

(1 mark)2. The company will be required to pay tax on the total rentals paid on

Lukonde’s apartment. The amount of income tax will be:

35/65 x K78,000 = K42,000 (1 mark)

(iii) Tax implications of provision of interest free loan to Lukonde:

1. Mwiko Limited will be deemed to have made a loan to an effective

shareholder as Lukonde has a shareholding of more than 5% in thecompany. (1 mark)

2. The company will be required to pay income tax at the rate of 35% onthe grossed up equivalent amount of the loan, not later than 14 daysfollowing the end of month (December 2013) when the loan was madeavailable to Mwiza. (1 mark)

3. The income tax payable on the loan will amount to;

35/65 x K650,000 = K350,000. (1 mark)

(b) The taxation implications if payment takes the form of a cash bonuspayment:

1. A bonus payment will be an allowable deduction when computing taxablebusiness profits. The company will therefore save tax at the rate of 35%. Theamount of tax saved will amount to: 35% x K150,000 = K52,500

2. The bonus salary will be assessed as a taxable emolument for Mwiza and will besubjected to income tax at the rate of 35% as her existing income is alreadyabove K70,800 for the tax year 2013. The additional income tax that she will paywill therefore be: 35% x K150,000 = K52,500.

3. No additional NAPSA contributions will be payable by either Mwiko Limited orMwiza because, her existing salary is already in excess of the NAPSA contributionearnings ceiling of K160,715.

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4. As a result of taking the lump sum payment of K150,000 as a bonus salary,Mwiza’s personal income tax will increase by K52,500, but there will be areduction of K52,500 in the company income tax for Mwiko limited.


Tax implications if payment were to take the form of a divided:

1. The dividend payment will not be an allowable deduction when computing thecompany’s taxable income. The dividend will instead be paid out of profitsalready subjected to company income tax.

2. The dividend will be subjected to withholding tax at the rate of 15%. This willamount to:

K15% x K150,000.

The withholding tax will be final tax and therefor Mwiza will not be subjected tofurther tax on the dividend.

3. NAPSA contributions will not be payable by both Mwiza and Mwiko Limited asdividends do not attract NAPSA contributions as they do not qualify as earningsfor the purposes of NAPSA contributions.

4. The dividend payment will result in additional tax of 15% payable by Mwiza butwill not result in any tax saving for the Mwiko limited.


END

l3 march 2014 q & a

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