UNIVERSITY OF DAR ES SALAAM

BUSINESS SCHOOL
DEPARTMENT OF ACCOUNTING

University Examination for the Programme of Bachelor of Commerce and Bachelor of Education [Commerce] for Academic Year 2009/2010 AC 204: TAXATION THEORY AND PRACTICE 1 Time allowed: 2 hours [17.00 19.00] Date: Tuesday, July 13th, 2010

Instructions to Candidates i] There are THREE questions in this examination. Attempt ALL ii] You should not use correcting fluid iii] All answers and workings should be written in the answer book provided. No workings should be done in the question paper at any time during the examination. iv] Be brief and straight to the point for theoretical questions. v] Marks for each question and parts thereof have been indicated to assist you in budgeting for your time wisely.

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Question ONE [22 marks] A] Mushi Brothers Ltd was recently registered in the united republic of Tanzania as a private company. Being in a very lucrative industry, processing of grain and locally selling foodstuff, it started making profit right away, booking a profit for tax purposes of TZS 40,000,000. The finance director, Mr Kinabo wants to avoid paying taxes in the first year of operation and thus wants to play around with residential status. To do this, he advises the chairman to convene all the Board of directors meetings in Malawi, so that Management and control is deemed to have taken place outside the united republic of Tanzania. The chairman agrees and thus implements the idea. Required: i] Briefly explain whether the idea of the finance director would be successful in affecting the residential status. [3 marks] ii] Supposing the company managed to be deemed as non-resident, would it assist in avoiding income tax on the TZS 40,000,000 profit? [3 marks] iii] Being a private company in food processing industry, what would be the tax payable, assuming the TZS 40,000,000 is taxable? [2 marks] iv] Supposing Mushi Brothers business was a partnership rather than a registered company and it happens to be resident in the year of income, what tax rate would have applied on the partnership profit [2 marks] v] Considering tax rates alone, would registering a company lead to a lower or a higher tax liability compared to a partnership business as far as the owners [shareholders/partners] are concerned [2 marks] B] Majimoto enterprises, a company listed in the Dar es salaam stock exchange is in the process of preparing income tax computations for the year of income 2009 and is doubtful on the appropriate treatment of an item on commissions of TZS 20,000,000 paid to secure business. Reading from the Income Tax Act 2004, the item is not specifically discussed. The Minister for finance had issued a regulation way back in 2007 that disallows commissions of the nature like the one in Majimoto enterprises. The finance director, Ms Tusijuane decides to allow the expenditure and submit the return of income for the year, the main argument being that the expenditure is generally allowable under section 11 (2) of the act as being wholly and exclusively incurred for the purpose of business. A mere regulation issued by the minister is not sufficient to affect the law, she argues. Required:

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Advise whether the finance director is right in treating the commission as an allowable expenditure, clearly indicating whether a proper reference to the tax laws has been used. [5 marks] ii] Assuming that the finance director is wrong in deducting the commission: a] State the most likely course of action by the commissioner responsible for income tax [3 marks] b] Compute the tax saving that the company was trying to make by deduction the commission [2 marks] i]

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Question TWO [18 marks] A] One of the criteria for evaluating tax systems efficiency is economy (administrative efficiency). Economy refers in this case refers to minimization of both compliance cost and administration cost. Required: i] Define compliance cost and administration cost, giving examples in each case [4 marks] ii] Give and explain briefly THREE examples of provisions in the Income Tax Act that are aimed at promoting minimization of compliance and/or administration cost. [6 marks] B] When a business underestimates the tax payable on installments, it is liable to interest as per Section 99 of the Income Tax Act 2004. Required: i] When would a business be deemed to have underestimated the tax? [2 marks] ii] Why is interest rather than penalty charged for that offence? [2 marks] iii] Identify a loophole in the income tax law in relation to this provision that a taxpayer could use to enjoy some benefit from underestimation and still pay little or no interest [4 marks] Question THREE [20 marks] The following information relates to Vuvuzela Co Ltd for the year ended 31st December 2009. TZS 000 TZS 000 283,16 Sales 5 127,33 Factory cost of sales 7 155,82 Factory profit 8 Expenses 37,02 General expenses 1 28,19 Marketing 7 16,03 Distribution 1 22,00 103,24 Finance costs 0 9 52,57 9 Other income 14,72 AC 204: Taxation Theory and Practice 1 for 2009/2010 Page 4 of 12

Profit before tax Corporation tax Profit after tax Dividend proposed and paid Retained profit for the year i]

3 67,30 2 30,00 0 37,30 2 23,00 0 14,30 2

Additional information: [all figures in TZS 000] Factory cost of sales includes: Depreciation [the company auditor attested that this was computed in accordance with IFRSs Partitioning plant office Repairs to factory premises to increase machine space

17,832,0 00 3,179,00 0 1,621,00 0

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ii]

General expenses include: Legal costs of income tax appeal Legal costs for issue of shares Stamp duty on property a new building acquired and used as office for the company. Fine on employees' motor vehicles Marketing expenses include: Trade debts written off Promotion gifts Advertising on TV Neon sign (purchase and installation) to display company name and brief profile Financial expenses include: Bank interest Bank charges Donation to political party for launching its campaigns near the company premises Subscription to trade associations Redundancy payments Loan to employee written off Increase in general bad debt provision Increase in specific bad debt provision 1,100,00 0 238,000 250,000 1,250,00 0 11,000,0 00 250,000 5,000,00 0 1,000,00 0 323,00 0 1,700,0 00 12,700, 000 627,00 0 175,000 1,200,0 00 250,00 0 1,211,000 1,800,000 6,000,000 10,000,00 0

ii]

v]

v]

Other income includes: Profit on sale of factory machinery [this machine had a book value of TZS 1000,000] Bad debts recovered Agency commission vi]

At the beginning of the year, the company had the following depreciable assets in its books: Class Class 1 Class 2 Class 3 Class 6 Cost [TZS] 62,000,0 120,000,0 20,000,0 300,000,0 AC 204: Taxation Theory and Practice 1 for 2009/2010 Page 6 of 12

Tax written down value [TZS] vii]

00 31,000,0 00

00 53,000,00 0

00 3,700,00 0

00 144,000,0 00

The Building in (ii) above was acquired for TZS 50,000,000. The building was furnished using imported furniture costing in total TZS 19,000,000.

Required: Showing all your workings clearly, compute the taxable business income for Vuvuzela Ltd for the year of income 2009 [20 marks]

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i]

Question ONE Mushi Brothers Ltd The finance directors idea: It will not be successful because a corporation is a resident corporation for a YOI if: it is incorporated or formed under the laws of the UR; or at any time during the YOI the management and control of the affairs of the corporation are exercised in the UR. Since it meets one of the two criteria, i.e. formed under the laws in the URT, then it is already a resident corporation whether or not it has met the second criterion. Avoiding income tax on the TZS 40,000,000 profit: It wouldnt avoid any income tax on the TZS 40,000,000. The chargeable income of a person depends on both residential status and source of income. For a resident person the income is chargeable irrespective of the source, while for a non-resident person, income is chargeable only if it has a source in the URT. Since the TZS 40,000,000 has a source in the URT, it is taxable whether or not the company is a resident person in the YOI Tax payable: This will be 30% of the TZS 40,000,000, i.e. TZS 12,000,000 What if it were a partnership? No tax rate would have applied on the partnership profit, but rather the individual tax rates would have applied to the partners after having the profit apportioned to the partners. Tax liability (partnership Vs company) For the owners, registering a company would attract a higher tax liability since: Companies are charged a flat 30% corporation tax rate, compared to individual rates charged to partners (ranging from 15% to 30% across different brackets) There will also be a tax on dividend on the shareholders apart from the corporation tax on the company profit (double taxation) Majimoto enterprises: Treatment of the commission: The Finance Director is not right in allowing the commission. This is because the sources of income tax laws in Tanzania include the Income Tax Act as well as the regulations issued by the minister of finance from time to time (among others). Since the regulation specifically refers to the AC 204: Taxation Theory and Practice 1 for 2009/2010 Page 8 of 12

ii]

iii] iv]

v]

i]

commission, then it would be a more appropriate reference than a reference from a general clause in the income tax act. ii] Course of action by the commissioner The most likely course of action by the commissioner is issuing an adjusted assessment, since the self assessment is inaccurate. Tax saving the company was trying to make This amounts to 25% of TZS 20,000,000, i.e. TZS 5,000,000. Question TWO A] Tax systems efficiency: Compliance cost and administrative cost Compliance cost cost incurred by the taxpayer in processing tax payments e.g. preparation of financial statements, tax returns, etc. Administrative cost Cost incurred by tax administrators/tax authorities in the collection of taxes, e.g. Tax audits, investigations, serving returns, etc. Provisions to minimize administration/compliance cost If installment is less than 12,500/- or 50,000 for a year the amount is carried forward to subsequent installments Penalties for failure to maintain documents or file a statement of estimated tax, where if the amount less than 100,000 for companies (10,000 for individuals) are paid at 100,000 (or 10,000) In computing depreciation allowances for class 1 3 depreciable assets (reducing balance method). If TWDV is less TZS 1,000,000, subsequent YOI depreciation allowance is the full TWDV Installments in agriculture/seasonal business Underestimation A business is deemed to have underestimated the tax when: Estimate is less than 80% of correct amount, or Difference btn estimate & correct amount is more than 20% of correct amount. Why interest? Since underestimation is considered a delay in paying the tax that would eventually be paid, thus equivalent to borrowing from the state for the period delayed. Loophole in this: The income & tax estimates may be revised at any time during the year of income if circumstances change. The installment payers estimate shall remain in force unless a revised estimate is filed that includes a statement of reasons for the revision [s. 89(5)]. As long as one can do this, then an underestimation may be subsequently covered towards AC 204: Taxation Theory and Practice 1 for 2009/2010 Page 9 of 12

iii]

i]

ii]

iii]

the end of the year with a revised estimate used to pay the final installment. This will benefit the taxpayer for a few months.

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Question THREE Taxpayer: Vuvuzela Ltd Computation of Taxable Income

Profit Before Taxes Add: Disallowed expenditure Depreciation Office partitioning Extension of factory premises Tax appeal costs Legal costs for issue of shares Stamp duty Fine on employees' motor vehicles Neon sign Bad debts written off Donation to political party Loan to employee written off Bad debts provision general Bad debts provision specific Less: Bad debts recovered Gain on sale of machinery Depreciation allowance 1,700,00 0 323,000 38,212,5 00 17,832,0 00 3,179,00 0 1,621,00 0 627,000 175,000 1,200,00 0 250,000 10,000,0 00 1,211,00 0 250,000 250,000 5,000,00 0 1,000,00 0 67,302,0 00

42,595,0 00 109,897,0 00

(40,235,5 00) 69,661,5 00

Class 2 53,000,00 0 Class 3 3,700,000 Class 6 144,000,0 00 3,179,000 1,621,000

TWDV at 1/1/2009 Additions: Partitioning plant office Repairs to factory premises

Class 1 31,000,00 0

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Stamp duty on building Acquisition of building Acquisition of furniture Neon sign (purchase and acquisition) 31,000,0 00 37.50% 11,625,00 0 53,000,0 00 25.00% 13,250,0 00 19,000,00 0 22,700,00 0 12.50% 2,837,500

1,200,000 50,000,00 0 10,000,00 0 210,000,0 00 5.00% 10,500,00 0

Depr rate Depreciation allowance

Total 38,212,500

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