- 10 Marks
Question
Kinky Ltd is a manufacturing entity resident in Ghana. Mr. Andre Camil, a citizen and resident of France, owns 90% of the company’s shares. Mrs. Claude Camil, a citizen and resident of France and wife of Mr. Andre Camil, also owns 5% of the shares of the company. Mr. Francois Camil, the son of Mr. Andre Camil, holds the remaining 5% of the shares in the company.
As at 1 June, 2021, the company had a share capital of GH¢400,000. A report submitted by the management to the Board of Directors indicated that the company needs to acquire a plant valued at GH¢1,000,000 to enable the company to increase its production capacity. Mr. Andre Camil, the majority shareholder, has offered to finance the purchase of the plant for the company but his challenge is whether to provide the asset to the company as a loan or as equity.
Required:
Advise Mr. Andre Camil on:
- The income tax treatment of providing the asset to the company as equity contribution.
- The income tax treatment of providing the asset to the company as a loan.
- The preferable option for providing the asset to the company in order to derive the maximum tax benefits.
Answer
- Income tax treatment of providing the asset to the company as equity contribution:
- The returns from providing the asset as equity will be in the form of dividends.
- Dividends are not deductible for tax purposes, which means they will not reduce the company’s taxable income.
- Dividend payments are subject to a withholding tax of 8% in Ghana.
- If the company is controlled by five or fewer persons, the Commissioner-General may treat part of the undistributed profits as deemed dividends and impose an 8% tax on those profits if the company fails to distribute a reasonable portion of its income to shareholders.
(4 marks)
- Income tax treatment of providing the asset to the company as a loan:
- The returns on a loan would be in the form of interest.
- Interest paid on debt obligations used for business purposes, such as purchasing the asset, is deductible for tax purposes, reducing the company’s chargeable income.
- Interest payments on loans to non-financial institutions (i.e., individuals or entities that are not banks) are subject to a withholding tax of 1%.
(3 marks)
- Preferable option for providing the asset to the company:
- Providing the asset as equity means that the dividends paid on this equity will not reduce the company’s taxable income, and dividends are subject to an 8% withholding tax.
- However, if Mr. Andre Camil provides the asset as a loan, the interest payments on the loan will reduce the company’s taxable income through deductibility. Additionally, the interest will only be subject to a 1% withholding tax.
- Therefore, from a tax perspective, it is preferable for Mr. Andre Camil to provide the asset as a loan to derive maximum tax benefits.
(1.5 marks for conclusion, 1.5 marks for justification)
- Tags: Capital structure, Equity contribution, Loan financing, Tax Benefits
- Level: Level 3
- Topic: Tax planning
- Series: JULY 2023
- Uploader: Theophilus