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QUESTION 2 40 marks
This question consists of two parts.
During the course of the audit of Cemer Holdings Ltd and its subsidiaries for the year ending
31 March 2004, a number of tax related issues have arisen. As the tax advisor you have been asked
to advise on two of these matters, which are set out below.
ISSUE 1 13 marks
During July 2003, IT Systems (Pty) Ltd, a Cemer Holdings Ltd subsidiary, won a R105 million
(excluding VAT) government tender for the provision of 21 000 personal computers to the Department
of Education i.e. at a price of R5 000 (excluding VAT) per computer. IT Systems (Pty) Ltd has to
manufacture the personal computers to set specifications.
IT Systems (Pty) Ltd received an advance payment of R5 million from the Department on
15 November 2003. This amount was used to partially finance the acquisition of new manufacturing
equipment in January 2004, at a cost of R6 million (excluding VAT), that will be used to manufacture
the personal computers. IT Systems (Pty) Ltd is expected to start actual production of the personal
computers, using the new manufacturing equipment, in June 2004. The total direct and indirect
manufacturing costs are estimated to be in the order of R4 000 (excluding VAT) per computer (i.e. the
gross profit is expected to be approximately 20% of the selling price).
The personal computers must be delivered to the Department at a fixed rate of 1 000 every month
from and including the month of July 2004. All 21 000 computers must be delivered to the
Department by March 2006. Ownership of the personal computers will pass upon delivery. The
Department will be invoiced on the last day of each month for that months deliveries. The amount
owed by the Department in respect of the deliveries for July 2004 (to be invoiced on 31 July 2004) will
be set off against the advance payment of R5 million received by IT Systems (Pty) Ltd in November
2003. Thereafter the Department must pay each invoice on or before the end of the following month.
On 1 July 2003 IT Systems (Pty) Ltd paid R60 000 for advertising space for 12 monthly issues of a
local IT magazine. This payment covers the monthly issues for the period 1 July 2003 to 30 June
2004.
REQUIRED
(a) State what amounts should be included in the taxable income of IT Systems (Pty) Ltd in each of
the 31 March 2004, 2005 and 2006 years of assessment as a result of the above transactions.
(4)
(b) State what amount(s) IT Systems (Pty) Ltd will be entitled to claim as a deduction or allowance
in each of these three years of assessment as a result of the above transactions. (9)
You may assume that all the entities are registered VAT vendors. Give reasons to support your
answers and show all workings.
ISSUE 2 27 marks
Properties (Pty) Ltd, a subsidiary of Cemer Holdings Ltd, owns the office building in which the
personnel of the Cemer Holdings Ltd group is located. All the shares in Properties (Pty) Ltd are held
directly by Cemer Holdings Ltd. The groups personnel only utilise one of the available five floors of
the office building. The remaining four floors of office space are rented out to third parties.
The management of Cemer Holdings Ltd is considering disposing of the building as the return on the
groups investment has been poor. This is mainly due to the inefficiency of the management of
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Properties (Pty) Ltd in administering the building and collecting rental from third party tenants. Cemer
Holdings Ltd is considering the following two options:
Option A: Sale of Properties (Pty) Ltd shares
Cemer Holdings Ltd has received an offer of R23 million from a third party for all the shares in
Properties (Pty) Ltd. In addition, its loan to Properties (Pty) Ltd of R4 million would be repaid in full
prior to transferring the shares to the third party.
Option B: Winding-up Properties (Pty) Ltd
Under this alternative Cemer Holdings Ltd would cause Properties (Pty) Ltd to dispose of its assets,
after which Properties (Pty) Ltd would be liquidated. If this option were followed, the following
amounts are expected to be realised by Properties (Pty) Ltd, net of any selling costs, on the sale of its
assets (see balance sheet set out below):
Office building
Trade receivables ceded to a factoring house without recourse
Motor vehicles
R million
21,0
8,2
0,7
Once the liquidator had settled all the Properties (Pty) Ltd liabilities, all surplus cash would be
distributed to Cemer Holdings Ltd.
The balance sheet of Properties (Pty) Ltd as at 31 March 2004 shows the following assets and
liabilities:
Notes R000
ASSETS
Office building
Motor vehicles
Trade receivables
Cash on hand
1
2
3
18 000
400
9 000
700
Total assets 28 100
EQUITY AND LIABILITIES
Capital and reserves
Share capital and share premium
Non-distributable reserve
Retained income
4
5
6
15 000
6 000
1 000
Shareholders funds 22 000
Liabilities and provisions
Loan from Cemer Holdings Ltd
Accounts payable
4 000
2 100
Total equity and liabilities 28 100
Notes
1 Office building
Properties (Pty) Ltd acquired this building in 1995 at a cost of R13 million. It was revalued in 1999 to
R18 million and the revaluation surplus was transferred to the non-distributable reserve (see note 5).
On 1 October 2001 Properties (Pty) Ltd revalued the building for capital gains tax purposes for an
amount of R19,5 million.
2 Motor vehicles
The vehicles originally cost R1,1 million in total. The book and tax values of the vehicles are the
same. None of the vehicles has a realisable (market) value in excess of its original cost.
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3 Trade receivables
These all relate to outstanding rentals due from third party tenants and arose during the previous two
financial years. The company has never previously factored its debtors.
4 Share capital and share premium
The share capital and share premium total R15 million, which includes capitalised reserve profits of
R5 million.
The company had only one capitalisation issue, a one for two issue, in 1999. The capitalised revenue
profits were earned during the March 1998 year.
5 Non-distributable reserve
The reserve consists of
Capital profit on sale in 1998 of a flat used by the directors
Revaluation surplus office building (see note 1)
R000
1 000
5 000
6 000
6 Retained income
Consists of only revenue profits earned during the March 2002 to March 2004 years.
7 Tax
The company has no assessed loss, no assessed capital loss and no secondary tax on companies
(STC) credits available.
Other information
The shares in Properties (Pty) Ltd originally cost Cemer Holdings Ltd R7 million in September 1985.
On 1 October 2001 Cemer Holdings Ltd valued the shares at R21 million for capital gains tax
purposes. Cemer Holdings Ltd has neither an assessed loss nor an assessed capital loss. Both
companies have elected not to use the Time Apportionment Base Cost method to calculate their
gains or losses for purposes of capital gains tax.
REQUIRED
Advise the Board of Cemer Holdings Ltd about which of the two options would result in Cemer
Holdings Ltd receiving the greater cash proceeds on disposal of its investment in Properties (Pty) Ltd,
after taking account of any tax resulting from the transactions. Give reasons and calculations to
support your advice. Ignore the future cost to the group of leasing office space, and under Option B
ignore the cost of liquidators fees.
