ATAX – Nov 2021 – L3 – Q4 – Capital Gains Tax (CGT)

Explanation of tax implications for transactions considered artificial involving connected persons.

Question

Colends Nigeria Limited, Abeokuta, is a manufacturer of plastic materials. The company is well known for prompt payment of taxes as at when due. The cordial relationship between the company and the Federal tax authorities is about to be breached as a result of disagreement in the classification of some transactions made by the company. The tax authorities considered those transactions to be artificial or fictitious, while the Managing Director, who is not an accountant, felt otherwise.

The company is in the process of re-organising its operations so as to compete favorably with its contemporaries, particularly with the implementation of the Africa Continental Free Trade Area Agreement (ACFTA) by some African countries.

The following transactions were concluded by the company during the financial year ended December 31, 2020:

Land and building acquired for ₦70 million on March 6, 2015, were sold for ₦125 million. Advertisement cost was ₦500,000, while the estate agent received a 5% commission of the sale proceeds.
Plant and machinery, which originally cost ₦28 million, were sold for ₦32 million to one of its subsidiaries, Colmas Limited. The market value of the assets sold was ₦40 million.
A saloon motor vehicle acquired for ₦5 million in 2017 was sold to the General Manager of the company for ₦3.5 million. The market value of the car was put at ₦5.5 million.
A giant generator that was acquired in 2018 for ₦12 million was disposed of for ₦15 million. The cost of disposal amounted to ₦200,000.

At a recent meeting of the board, the following transactions were approved and implemented in December 2020:

Acquisition of a large acreage of land and a building in the outskirts of the city-center for the business at ₦100 million.
Purchase of a modern plant and machinery for ₦50 million.
A saloon motor vehicle was purchased for ₦10 million.
A brand new generator costing ₦20 million was acquired.

Colends Nigeria Limited has recently appointed you as its tax consultant.

Required:

Draft a report to the Managing Director of the company explaining:

a. The concept of connected persons and artificial transactions. (4 Marks)
b. The tax implications, if any, on transactions executed by the company in accordance with the provisions of the Capital Gains Tax Act Cap C1 LFN 2004 (as amended). (16 Marks)

Answer

ToksBlaqy & Co. (Tax Consultants)
20, Camp Road, Abeokuta
January 22, 2021

To: The Managing Director, COLENDS Nigeria Limited, Abeokuta

Subject: Connected Persons, Artificial Transactions, and Tax Computation

We refer to your memo dated January 10, 2021, and our meeting with the company’s management on January 12, 2021, seeking our services as tax consultants to address the subject matter. Our comments are as follows:

a. Connected Persons and Artificial Transactions

The concept of connected persons and artificial transactions in tax practice is explained as follows:

Connected Persons: Certain persons are treated as so closely involved that transactions between them need to be viewed as if they are the same person or considered differently from those at “arm’s length.”
Artificial or Fictitious Transactions: Transactions between connected persons may be considered artificial for determining tax liability, allowing tax authorities to make necessary adjustments to prevent reduced tax liability.
Adjustments by Revenue Service: The Revenue Service may counteract reductions in tax liability from such transactions by making necessary adjustments.
Capital Gains Tax Act Provisions: Section 23 of the Capital Gains Tax Act 2004 (as amended) specifies that transactions between connected persons must be treated as occurring outside the “bargain at arm’s length” principle, with considerations adjusted to market value.
Specific Company Transactions: The disposal of Colends Nigeria Limited’s plant and machinery to a subsidiary and the saloon vehicle to the General Manager are clear examples of artificial transactions, as these persons are connected to the company. The Revenue Service therefore substituted the proceeds received (₦32 million for machinery and ₦3.5 million for the car) with their market values (₦40 million and ₦5.5 million, respectively).

b. Tax Implications on Transactions Executed

Roll-over Relief Eligibility: Section 32 of the Capital Gains Tax Act allows for roll-over relief on qualifying assets. Relief is granted if consideration from the disposal of an old asset, used exclusively for trade, is reinvested in a similar new asset.
Roll-over Relief Deduction: The roll-over relief is deducted from capital gains before determining capital gains tax payable.
Asset Eligibility for Roll-over Relief: All disposed assets, except the motor vehicle, qualify for roll-over relief.
Tax Liabilities Summary:
- Land and Building: ₦1,825,000 as capital gains tax
- Plant and Machinery: ₦0 (roll-over relief applied)
- Saloon Motor Vehicle: ₦50,000 capital gains tax
- Generator: ₦0 (roll-over relief applied)
Total Tax Payable: ₦1,875,000.