- 20 Marks
Question
The board of directors of Dragbat Limited, Lagos, a medium-sized company, at its last meeting, deliberated on the company’s tax-related issues vis-à-vis one of its major competitors in the same line of business. The Managing Director presented the audited accounts of the two companies for the previous three years. He affirmed that their company has been paying more corporate and tertiary education taxes than their competitors, while returning lower profit before tax in each of the years under review. The board has since directed the Managing Director to do a thorough investigation on how competitors, according to the Chairman of the board, are having it easy with the tax authorities.
With the assistance of a former course-mate in the university, who works in the Finance unit of a competitor’s organisation, the Managing Director was informed that the competitor was involved in tax planning and tax avoidance activities, which have helped in reducing the company’s tax liabilities over the years.
Being an engineer with sparse knowledge of accounting and taxation, the Managing Director has contacted you as the company’s tax consultant to help explain some fundamental issues in tax planning and tax avoidance. To assist with this assignment, the Managing Director of Dragbat Limited provided you with the audited financial statements of the two competing companies for the last three years. He also informed you that the major difference between the two companies is that Dragbat Limited is servicing a loan facility of ₦120 million obtained five years ago, and the company is not finding it comfortable in implementing the terms of the loan, despite its increased profitability over the last three years.
The board will be meeting in a fortnight to consider the report on the preliminary investigation, and the Managing Director expects you to submit your report to him next week.
Required:
As the company’s tax consultant, you are expected to address and advise on the following issues in your report:
a. The concepts of tax planning, tax avoidance, and thin capitalisation. (9 Marks)
b. Tax planning activities and strategies. (6 Marks)
c. Tax implications for companies that practice tax planning, tax avoidance, and thin capitalisation. (5 Marks)
Answer
Sunny & Co. (Tax Consultants)
Success Avenue
Lagos
October 4, 2021
To: The Managing Director, Dragbat Limited
Independence Road, Lagos
Subject: ADVICE ON TAX PLANNING, TAX AVOIDANCE, AND THIN CAPITALISATION
Dear Sir,
Following our recent discussions on the tax-related issues affecting Dragbat Limited, we have completed our assessment and hereby provide the following explanations and recommendations:
a. Concepts of Tax Planning, Tax Avoidance, and Thin Capitalisation
- Tax Planning:
Tax planning involves legally arranging financial activities to minimize tax liabilities. Techniques include utilizing tax deductions, credits, and exemptions to reduce taxable income. - Tax Avoidance:
Tax avoidance refers to legally exploiting tax laws to reduce tax liabilities. Unlike tax evasion, tax avoidance adheres to the law but seeks to minimize tax burden by using permissible deductions and credits. - Thin Capitalisation:
This occurs when a company is financed through a relatively high level of debt compared to equity. It is often a strategy to reduce tax liability by claiming interest deductions on debt, which may lead tax authorities to scrutinize the company’s debt structure.
b. Tax Planning Activities and Strategies
- Use of Tax Incentives: Leveraging incentives, such as investment tax credits, encourages reinvestment.
- Maximizing Deductions: Ensuring allowable deductions, such as depreciation and charitable donations, are fully utilized.
- Capital Allowances: Efficient use of capital allowances on qualifying assets to defer or reduce tax liabilities.
- Loss Carryforward: Using previous losses to offset taxable profits in future years, reducing tax payable.
- Group Relief: Where applicable, utilizing losses within a group structure to offset profits of other group companies.
c. Tax Implications on Companies Engaging in Tax Planning, Tax Avoidance, and Thin Capitalisation
- Compliance with Tax Laws: Companies must ensure all tax planning activities comply with local laws to avoid penalties.
- Increased Scrutiny from Tax Authorities: Engaging in thin capitalisation and tax avoidance may lead to heightened inspections by tax authorities.
- Interest Deduction Limitations: Certain jurisdictions impose restrictions on interest deductions if debt levels exceed a specific threshold.
- Reputational Risk: Aggressive tax avoidance practices can affect a company’s reputation and its relationship with tax authorities.
- Risk of Reclassification: Tax authorities may reclassify transactions deemed to be artificially structured for tax benefits, leading to additional liabilities.
Should you require further clarification, please feel free to contact us.
Yours faithfully,
Sunny & Co. (Tax Consultants)
- Topic: Tax Planning and Management
- Uploader: Kofi