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Transfer Pricing and Thin Capitalisation – S 31

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VALUE ADDED TAX (VAT)
Imposition of VAT (section 7) Vat is levied on  the supply  by any vendor  of goods or services  on or after (30/09/91) the commencement of date any

 in the course or furtherance enterprise carried on by him. Key definitions (section 1)  Supply

 Goods – includes capital goods & fixed property  Services  Vendor  Enterprise

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COMPUTATION OF VAT PAYABLE

Output VAT Less: Input VAT VAT Payable / Receivable

XXX XXX (XX XXX) XXX XXX

TYPES OF SUPPLIES SUPPLIES TAXABLE SUPPLIES EXEMPT SUPPLIES

STANDARD RATE - 14%

ZERO RATE - 0%

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Zero-rated supplies (section 11) Goods (section 11(1)) : P676  Exported goods (section 11(1)(a))  Sale of an enterprise as a going concerns (section 11(1)(e) and Practice Note 14)  Goods used or consumed for agricultural or farming purposes (section 11(1)(g) and Part A of Schedule 2)  Fuel, eg. Petrol & diesel (section 11(1)(h))  Certain basic foodstuffs (section 11(1)(j) and Part B of Schedule 2) Services (section 11(2)):  International transport (section 11(2)(a))  Ancillary transport services (section 11(1)(c) and (d))  Municipal property rates

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Exempt supplies (section 12) Financial services (section 12(a) and section 2):  Excluding fee based financial services. Supply of accommodation in a dwelling (section 12(c)) Transport services by road or rail of fare paying passengers and their personal effects (section 12(g)) Educational services (section 12(h))  Trade union contributions (section 12(i)).  Creche or after-school care centre (section 12(j))

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Deemed supplies (section 8 and 18) Ceases to be a vendor (section 8(2))  Any goods (excl those for which an input tax deduction was denied ito s17(2)) or rights which form part of the assets of his enterprise shall be deemed to be supplied.  Value of supply : [S10(5)]  Consideration = lesser of cost or open market value  Time of supply :  Immediately before ceases to be a vendor

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Deemed supplies cont. Indemnity awards (section 8(8)) – P670  Short term insurance premiums - input credit permitted.  Deemed supply arises when :  Payment is received by the vendor or  Vendor is indemnified by the payment of money to another person.  Exceptions : Indemnity payment received by the vendor, total reinstatement of goods stolen or damaged beyond economic repair, and vendor was denied an input tax credit.  Value of supply :  Apply tax fraction to payment  Time of the supply :  Tax period when payment is received

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Deemed supplies cont.
Example 1: Indemnity awards A (Pty) Ltd pays an annual insurance premium of R6 840 (inclusive of VAT) to insure a motor car that is used for trade purposes. The VAT on the insurance premium of R840 (R6 840 × 14 / 114) is deductible as an input tax credit by A (Pty) Ltd. The motor car is damaged in an accident. The insurer pays A (Pty) Ltd R17 100. A (Pty) Ltd then pay a panel beater R17 100 for the repairs made to the motor car. Suggested solution A (Pty Ltd must account for output VAT of R2 100 (R17 100 × 14 / 114) on the proceeds received from its insurer in terms of section 8(8). On receipt of a tax invoice from the panel beater, A (Pty) would be entitled to claim an input tax deduction of R2 100. Example 2: Indemnity awards Assume the facts are as in example 1 except that the motor car is stolen and the insurer pays A (Pty) Ltd R100 000. Suggested solution No output VAT is payable as the deemed supply provisions of section 8(8) do not apply when the indemnity payment is for the total reinstatement of goods stolen or damaged beyond economic repair and the vendor was denied an input tax deduction on those insured goods in terms of section 17(2).

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Deemed supplies cont.  Amounts received in excess of consideration charged (section 8(27)) P672  Taxable supply of goods and services made at the rate of 14% and  the payment received exceeds the consideration charged and  such excess has not been refunded within four months of receipt  that excess amount shall be deemed to be a supply of services by the vendor  vendor must account for output tax on the excess amount by the last day of the tax period during which that four month period.

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Deemed supplies cont.
Example: The following journal entry appeared in the books of A (Pty) Ltd. Debtors To Creditors Dr 15 960 15 960

Being a transfer from debtors to creditors. A local customer had settled its account in full on 31 August 2008 for R15 960 (R14 000 plus VAT of R1 960). It had settled this same account again on 30 September 2008 when it paid another R15 960 to A (Pty) Limited. Prepare the correcting journal entry Suggested solution Creditors Dr 1 960 To VAT output account 1 960 Being a deemed supply on the overpayment of a debtor’s account. Explanation In terms of section 8(27), a deemed supply arises when an overpayment of a 14%-taxable supply is not refunded within four months of its receipt – 31 January 2009.

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Deemed supplies cont. Fringe benefits (section 18(3)) P689  Vendor grants a benefit or advantage to an employee or office holder which falls into gross income ito para (i) of the gross income definition - deemed supply.  Excludes :  Exempt supplies  Zero rated supplies  Supply of entertainment  Granted in the course of making exempt supplies  Supplies where input tax credit denied – (section 8(14))  Value :  Consideration = cash equivalent ito Seventh Schedule (Except for right use of a motor vehicle) [S10(13)]  Time of supply : [S9(7)]  End of the month when benefit incl. in the employee's remuneration / YOA

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Deemed supplies cont.
The table below shows if a benefit or advantage granted to an employee or office holder constitutes a deemed supply for the purposes of section 18(3).
Taxable benefit Asset given to employee Deemed supply Yes (unless an input tax deduction was denied to the employer) Use of asset Use of company car Meals and refreshments Residential accommodation Free or cheap services Low-interest loans and subsidies Medical aid contributions Payment of a debt of an employee Release of an employee from a debt owed to his employer Travelling allowance Subsistence allowance Entertainment allowance Share option gains Yes Yes No No Yes No No No Yes Reason Seventh Schedule fringe benefit.

Seventh Schedule fringe benefit. Seventh Schedule fringe benefit. Excluded in terms of section 18(3). An exempt supply. Seventh Schedule fringe benefit. An exempt supply. An exempt supply. An exempt supply. Seventh Schedule fringe benefit. This is not an exempt supply because it is not the issue of a debt security. Not a Seventh Schedule fringe benefit. Not a Seventh Schedule fringe benefit. Not a Seventh Schedule fringe benefit. An exempt supply.

No No No No

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Deemed supplies cont. Fringe benefit = right of use of motor car : P742  Output tax (each month) = consideration x 14/114  Where consideration =  Determined value x 0.3% if employer denied an input tax credit,  Determined value x 0.6% if employer claimed an input tax credit - reduced by amount paid by employee for right of use  Determined value = original cost in arms length transaction excl. finance charges, interest, sales tax or VAT.  Adjustments to consideration  Reduce by lesser of R85 / actual cost pm where employee bears the full cost of maintenance (no reimbursement)

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Input Tax Definition Input tax is defined in section 1 as:  The VAT paid to a supplier on the acquisition of good and services by a vendor.  The VAT paid by a vendor on the importation of goods.  The tax fraction of the cost of second-hand goods (see below) acquired from a nonvendor (‘notional’ or deemed input tax).  An amount equal to the tax fraction of goods repossessed under an instalment credit agreement. acquired wholly or partly for the purpose of consumption, use or supply in the course of making taxable supplies (standard- or zerorated supplies).  in possession of a valid tax invoice.  Claim within 5 years from the end of the tax period during which entitled to claim

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Notional Input Tax (definition of 'input tax' and section 16(3)) Occurs when  A vendor  Acquires second-hand goods (situated in the Republic)  From a non-vendor who is a resident  wholly or partly for the purposes of making taxable supplies. Lesser of consideration and open market value x tax fraction (at time of supply) Can only be claimed to the extent payment has been made Special rules apply to second hand fixed property and shareblock shares  Limited to transfer duty or stamp duty (apportioned if applicable)  Deductible only in tax period when full or final amount of transfer or stamp duty has been paid.

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Input Tax cont. Apportionment (section 17(1))  When goods or services are acquired partly for the purpose of making taxable supplies and partly for another intended use.  Section 17(1) provides that the input tax incurred must be apportioned in the following ratio:
Total value of taxable supplies (excluding VAT) Total value of all supplies (excluding VAT)

 Exception :  When intended use for making taxable supplies is 95% or more - deemed to have been acquired wholly for the purpose of making taxable supplies

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Denied input tax deductions (section 17(2)) P687 Entertainment (section 17(2)(a))  Definition in section 1 Exceptions :  Vendor makes taxable supplies of entertainment:  Entertainment enterprises must cover costs or charge OMV, except :  If bona fide promotion to customers and similar to entertainment normally supplied  Excess food not consumed given to employees or welfare organization.  Entertainment supplied to employee / office holder / connected person and a charge is made which covers all the direct and indirect costs.  Personal subsistence of vendor or employee in respect of 'out-of-town' business trips (away at least 1 night)  Taxable passenger transport services  Seminars or similar events for reward

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Denied input tax deductions cont. Fees or subscriptions in respect of membership of any club, association or society of a sporting, social or recreational nature (section 17(2)(b)) Motor cars (section 17(2)(c))  Definition in section 1 P664  Incl. motor car, station wagon, minibus, double cab light delivery vehicle  Normally used on public roads  Three or more wheels  Constructed or adapted wholly or mainly for the carriage of passengers  Exclusions  Exceptions  Motor cars acquired exclusively for the purpose of making taxable supplies  Demo vehicles or acquired for a temporary use prior to a taxable supply  acquired for the purpose of awarding that motor car as a prize  Other costs that may be claimed

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Example: Motor Car On 1 December 2008 Moon (Pty) Limited purchased, for cash, a motor car for the use of its sales director. This motor car cost R139 080 (including VAT of R17 080). The use of it was given to the sales director as a ‘company car’ with effect from 1 December 2008. Prepare the journal entries required to record the purchase of the motor car and the resulting fringe benefit in the accounting records of Moon (Pty) Limited? Suggested Solution Motor car Dr 139 080 To Bank 139 080 Being a motor car purchased for cash. Salaries and wages Dr 45 To Vat output account 45 Being output tax payable on the fringe benefit of the use of the motor car given to the sales director. Because the item purchased is a ‘motor car’ as defined, no input tax credit is available on its purchase (section 17(2)(c)). The fringe benefit of the use of the motor car constitutes a deemed supply by Moon (Pty) Limited. It is therefore required to account for output tax of R45 (R122 000 × 0,3% = R366 × 14 / 114 × 1 month) on the deemed supply (section 18(3)). (The determined value of the ‘motor car’ is R122 000 (R139 080 × 100 / 114).)

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Instalment credit agreements  Definition – section 1  Time of supply [S9(3)(c)] Earlier of: when delivery takes place, or when payment is made  Section 23C of the Income Tax Act

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Instalment credit agreements Example Indigo Limited acquired a new manufacturing machine at a cost of R171 000 under an instalment credit agreements. . The details of the ICA are as follows: Cost of machine Add value-added tax (vat) Principal debt Add finance charges Total amount due 150 000 21 000 171 000 69 000 240 000

The ICA is payable in sixty monthly instalments of R4 000 each. Suggested solution if ICA is a financial lease The lease rentals incurred of R4 000 per month are tax deductible. But the deductible amount must first be reduced by the VAT that is included in each monthly rental. The total VAT is R21 000. It is for a sixty month period. The vat for each month is therefore R350 (R21 000 / 60 months). The deductible lease rental is then R3 650 (R4 000 – R350) pm.

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Adjustments Bad debts (section 22(1))  Deduction = the VAT portion of the consideration written off  Account for as input tax deduction  Zero rated – no deduction

Recovery of bad debts (section 22(2))  If a debt is wholly or partly recovered, output tax must be accounted for on the amount recovered during the tax period when it is recovered

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Example: Bad Debts Bad debts, inclusive of vat (relating to sales made during its 2008 financial year) were written off in the accounting records of Blue Moon (Pty) Limited as being irrecoverable: Pencil Pot (Pty) Limited (a local debtor) Inkwell (Pty) Limited (an export debtor) Pens ‘n Things (Pty) Limited (a local debtor) 7 638 6 270 9 804 23 712 Prepare the journal entry to record the write-off of these bad debts in the accounting records of Blue Moon (Pty) Limited? Suggested solution Bad debts Input vat account To Debtors Dr 21 570 Dr 2 142 23 712

Being bad debts written off at 30 December 2008.

The write off of the local debtors gives rise to an input The write off of the local debtors gives rise to an input tax adjustment of R2 142142 ((R7 638 R9 804) ××14 // 114) in term tax adjustment of R2 ((R7 638 + + R9 804) 14 114) ofin terms of section 22(1). The write off export debtor does no section 22(1). The write off of the of the export debtor an input tax adjustment as the sale to the result indoes not result in an input tax adjustment as export the sale to the export debtor constituted a debtor constituted a zero-rated supply. zero-rated
supply.

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Adjustments cont. Long-outstanding creditors (section 22(3) and 22(4))  Invoice basis of accounting for VAT  Made a deduction of input tax, and  Not paid the full consideration within 12 months after the expiry of the tax period when deduction made,  Deemed output tax in next tax period = tax fraction x consideration not paid  If subsequently settle then input tax deduction = tax fraction x amount paid

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Example: Long-outstanding creditors
In December 2007 Yellow Limited bought trading stock for R23 940 (R21 000 plus vat of R2 940) from a local supplier. Yellow Limited claimed an input tax credit of R2 940 in its tax period 1 December 2007 to 31 December 2007. Yellow Limited encountered quality problems with this trading stock and paid the supplier only R19 152 (R16 800 plus vat of R2 352) on 31 January 2008. It refused to settle this account until the quality problems were resolved. On 31 January 2009 R4 788 (R4 200 plus vat of R588) was still outstanding despite numerous letters of demand having been received from the supplier. You are required to determine if there are any vat consequences that results from this debt being outstanding for more than a year. Suggested solution Yellow Limited claimed an input tax deduction of R2 940 in its tax period 1 December 2007 to 31 December 2007. A portion of the consideration had not been settled by 31 December 2008 (twelve months after the tax period when the input tax was claimed). Yellow Limited must therefore raise a deemed output tax of R588 being the tax fraction (14 / 114) of the portion of consideration that has not been paid. This amount has been calculated as follows: R4 788 × 14 / 114 = R588.

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Adjustments cont. Change of use adjustments : Section 18(1)  Goods or services acquired for making taxable supplies and,  Subsequently applied wholly for private, exempt or another non-taxable use  Deemed supply and adjustment to output tax  Value (section 10(7)) :  14/114 x open market value.  Time :  Tax period in which the change of use occurs  If full input tax credit was not claimed on acquisition then an input tax adjustment = lesser of cost (incl. VAT) and market value x % input credit not claimed x 14/114 (section 16(3)(h))

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Change of use adjustments : Section 18(1) Example On 1 March 2008 G (Pty) Limited purchased a new electric lawnmower for R2 052 (R1 800 plus vat of R252). This lawnmower was used by G (Pty) Limited for the month of March. When it was found to be ‘underpowered’ for mowing larger lawns, Sam Deal, the sole director and shareholder of G (Pty) Limited, took the lawnmower home for his domestic use. G (Pty) Limited had attempted to sell the lawnmower but the best offer received for it was R1 710 (R1 500 plus vat of R210). You are required to draft the journal entries to record the above transactions. Suggested solution Equipment (lawnmower) Input vat To Bank Being purchase of an electric lawnmower. Loan account – Sam Deal Output vat To Equipment Being the removal of an electric lawnmower from G (Pty) Limited by Sam Deal for private use. 1 800 252 2 052

1 710 210 1 500

Explanation The purchase of the electric lawnmower gives rise to an input tax deduction because it was purchased for making taxable supplies, in the course or furtherance of G (Pty) Limited’s enterprise (section 17(1)). The removal of the electric lawnmower by Sam for his private use gives rise to a change of use adjustment in terms of section 18(1). The output tax is calculated on its market value: R1 710 × 14 / 114 = R210.

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Fixed property transactions Time of supply:[s9(3)(d)]  the earlier of: • the date of registration of transfer • the date on which any payment is made of the consideration for such supply.

The position of the seller:
  

  

the supply of fixed property by a vendor in the course or furtherance of an enterprise carried on by him must be charged with VAT unless the supply is an exempt supply output VAT is raised to the extent of payment received.

  

if the seller is not a registered vendor no supply takes place and thus no VAT is charged.

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Fixed property transactions cont The position of the buyer:
  

 

if the buyer paid VAT on the purchase no transfer duty is payable by him and he uses the property to make taxable supplies he may claim the input tax back claim to the extent of payment made if the buyer paid VAT on the purchase but he does not use the property to make taxable supplies he may not claim the input tax back no transfer duty is payable by him

 

 

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Fixed property transactions cont The position of the buyer: (cont)
  



if the buyer did not pay VAT on the purchase he must pay transfer duty and he uses the property to make taxable supplies, he may claim a notional input tax deduction • notional input tax is the tax fraction of the lesser of: - open market value and - cost price • notional input tax is limited to transfer duty paid and may be claimed in the period in which the transfer duty is paid • no regard is taken of the extent of any payment

 





if the buyer did not pay VAT on the purchase nor does he use the property to make taxable supplies he may not claim a notional input tax deduction but he must pay transfer duty.

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Example: Fixed property transactions cont
On 2 December 2008 P (Pty) Limited purchased a vacant plot of land from a person not registered for VAT purposes. The purchase price of R250 000 was paid by P (Pty) Limited on the registration of transfer of the land on 28 December 2008. Transfer duty of R20 000 was also paid on 28 December 2008 for the transfer of this property into the name of P (Pty) Limited. It intends to erect a new factory on the land in its next financial year. How should the purchase of this land have been recorded in the accounting records of P (Pty) Limited? Suggested Solution Land Dr 250 000 Input vat account Dr 20 000 To Bank 270 000 Being settlement of the purchase consideration and the transfer duty for the land purchased. The land purchased by P (Pty) Limited constitutes a ‘secondhand good’ as defined. As the land was purchased from a non-registered person, no vat would have been levied on the supply. P (Pty) Limited is, however, entitled to claim a ‘notional’ or ‘deemed’ input tax credit on the purchase of the second-hand goods. But then because the second-hand good comprises fixed property, the ‘notional’ or ‘deemed’ input tax credit is limited to the transfer duty payable. The notional input tax credit of R30 702 (R250 000 × 14 / 114) is therefore limited to the R20 000 transfer duty paid. A further condition is that the notional input tax credit may be claimed only in the tax period when the transfer duty is paid. (See definition of ‘input tax’.)


				
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