- 30 Marks
Question
Soft Farm and Agro-Allied Limited, a subsidiary of Emperor Agro Incorporated, Italy, was incorporated in Nigeria in January 2018. Soft Farm and Agro-Allied Limited produces palm kernel for domestic use and export to the European market. The Managing Director of the company has just received a letter from the head office (parent company) about an impending visit due to poor business performance (below the group’s return on investment benchmark of 25%) since the business commenced, despite financial and technical support from the parent company.
In January 2022, the parent company granted a loan of N100 million to Soft Farm and Agro-Allied Limited for business expansion.
The Board has scheduled a special meeting for next month to consider the financial report of Soft Farm and Agro-Allied Limited for the year ended December 31, 2022, and to review past financial reports and tax assessments. As the newly engaged Tax Consultant to the company, you have been invited to participate in the meeting to provide a professional opinion on tax-related issues.
The Financial Accountant has been directed by the Managing Director to provide you with financial statements for all periods under review, books of accounts, returns filed with tax authorities, and other supporting documents.
From your preliminary review of the financial report for the year ended December 31, 2022, you noted an item that requires further discussion with management. This issue relates to interest paid on a loan obtained from the parent company.
Extract from Financial Statements for the Year Ended December 31, 2022
| Item | N’000 |
|---|---|
| Gross turnover: | |
| – Domestic sales | 147,500 |
| – Export sales | 200,100 |
| – Other operating income | 3,300 |
| Total Gross Turnover | 350,900 |
| Deduct: | |
| – Staff salary | 122,600 |
| – Ground rent paid to State government | 3,200 |
| – Motor running expenses | 1,750 |
| – Audit and accountancy fees | 1,000 |
| – Repairs and maintenance | 5,800 |
| – Depreciation of assets | 38,240 |
| – Rent paid | 1,850 |
| – Power and lighting | 5,400 |
| – Legal cost | 5,000 |
| – Rates (water) | 2,100 |
| – Allowance for doubtful debts | 10,500 |
| – Donations | 4,000 |
| – Interest and other finance costs paid | 15,600 |
| – Income tax provision | 23,400 |
| – General expenses | 5,900 |
| Total Deductions | 246,340 |
| Net Profit | 104,560 |
Additional Information:
- Export Sales:
20% of export sales were made to the parent company at the prevailing international market price. - Other Operating Income:
Description N’000 Dividend received (net) 2,700 Profit from disposal of non-current asset 600 Total 3,300 - Repairs and Maintenance:
Description N’000 Repairs of plantation equipment 1,200 Repairs to premises (non-industrial building) 900 Expansion to warehouse (industrial building) 3,700 Total 5,800 - Rent Paid:
This amount is for accommodation for the newly employed General Manager, whose basic salary is N4,800,000. - Legal Cost:
Description N’000 Cost of income tax appeal 850 Cost of debt collection 1,300 Cost of acquiring new lease 1,700 Renewal of old lease 1,150 Total 5,000 - Allowance for Doubtful Debts:
Description N’000 Specific provisions 5,230 General provisions 7,870 Bad debts recovered (2,600) Total 10,500 - Donations:
Recipient N’000 Palm Oil Research Institute 1,400 National Library 600 Cocoa Research Institute of Nigeria 1,000 Women Society of the host community 1,000 Total 4,000 - Interest and Other Finance Costs Paid:
In January 2022, the company obtained a loan facility of N100 million from the parent company for business expansion at a competitive interest rate of 12% per annum. The loan duration is 10 years, with interest payable for the first three years, and principal and interest repayments due from the fourth year onward. The balance in the financial statements includes other finance costs and bank charges paid to domestic banks on various accounts. - General Expenses:
Description N’000 Wedding gift to staff 350 Fine imposed on company driver for traffic offense 150 Haulage expenses 3,200 Transport and travelling 2,200 Total 5,900 - Schedule of Prior Years’ Turnover and Assessable Profits:
Year Ended December 31 Turnover (N’000) Assessable Profit (N’000) 2018 154,400 78,750 2019 198,600 95,120 2020 310,300 142,800 2021 314,900 166,900 - Schedule of Qualifying Capital Expenditure Incurred:
Date of Acquisition Asset Type Amount (N’000) August 31, 2017 Plantation equipment 4,600 August 31, 2017 Industrial building 12,000 August 31, 2017 Non-industrial building 9,000 January 1, 2018 Motor vehicles (3) 8,400 January 1, 2018 Furniture and fittings (10) 1,500 February 14, 2021 Motor vehicles (2) 5,600 June 12, 2022 Furniture and fittings (10) 2,000 July 8, 2022 Research and development 7,000
Required:
As the Tax Consultant to the company, draft a report to the Managing Director of Soft Farm and Agro-Allied Limited, in line with the provisions of the Companies Income Tax Act Cap C21 LFN 2004 (as amended). The report should provide professional advice on the following:
- Treatment of Excess Amount of Deductible Interest Paid (6 Marks)
- Adjusted Profit of the Company for the Year Ended December 31, 2022 (7 Marks)
- Tax Liabilities for All Relevant Assessment Years (17 Marks)
Answer
DEBBY TAX CONSULTANTS
Benin-City
Date:
To: The Managing Director
Soft Farm and Agro-Allied Limited
Benin-City
Subject: Treatment of Excess Amount of Deductible Interest Paid and Computations of Adjusted Profit and Tax Liabilities
We refer to your request regarding the treatment of deductible interest, computation of adjusted profit, and tax liabilities for the company’s financial activities in the relevant assessment years. Our comments are as follows:
(a) Treatment of Excess Amount of Deductible Interest Paid on Foreign Loan
In accordance with the loan agreement, the company is expected to pay N12 million in interest on the N100 million facility obtained from the parent company by December 31, 2022. This N12 million was correctly captured in the financial report by the Financial Accountant.
However, as per paragraph 2 of the 7th Schedule to the Finance Act 2019, allowable deductible interest on foreign loans is capped, with any excess considered a disallowable deduction for tax purposes. “Excess interest” is defined as interest paid exceeding 30% of earnings before interest, taxes, depreciation, and amortization (EBITDA) of the Nigerian company for the given accounting period.
The foreign loan interest of N12 million (12% of N100 million) is less than the 30% threshold of N54.54 million. Consequently, the interest deductibility rule did not affect the company.
(b) Adjusted Profit for the Year Ended December 31, 2022
As outlined in Appendix 2, the adjusted profit for the year ended December 31, 2022, is N178,520,000.
(c) Tax Liabilities for Relevant Assessment Years
Appendix 3 provides details of the company’s income tax and tertiary education tax payable for the 2018 through 2023 assessment years.
Yours faithfully,
For: DEBBY TAX CONSULTANTS
Deborah Oguns
Principal Partner
Appendix 1: Computation of Excess Deductible Interest Paid
- Loan Amount: N100 million
- Interest Rate: 12% per annum
- Interest Paid: 12% of N100 million = N12 million
- Excess Deductible Interest Threshold: 30% of EBITDA
| Description | N’000 |
|---|---|
| Net Profit | 104,560 |
| Add: | |
| – Interest | 15,600 |
| – Depreciation | 38,240 |
| – Income Tax | 23,400 |
| EBITDA | 181,800 |
- Maximum Allowable Interest Deduction: 30% of N181,800 = N54,540
- Since N12 million is below the N54.54 million threshold, the interest deduction rule does not apply.
Appendix 2: Adjusted Profit Calculation
| Description | N’000 |
|---|---|
| Net Profit as per Accounts | 104,560 |
| Add Back: | |
| – Expansion to Warehouse | 3,700 |
| – Depreciation | 38,240 |
| – Income Tax Appeal | 850 |
| – New Lease Acquisition | 1,700 |
| – General Provisions (Allowance) | 7,870 |
| – Donation (Women Society) | 1,000 |
| – Income Tax Provisions | 23,400 |
| – Wedding Gift | 350 |
| – Traffic Fine | 150 |
| Subtotal | 77,260 |
| Adjusted Profit | 181,820 |
| Less: | |
| – Dividends Received | 2,700 |
| – Disposal Profit | 600 |
| Adjusted Profit | 178,520 |
Appendix 3: Tax Liabilities by Year
2018 Assessment Year (Basis Period: 1/1/18 – 31/12/18)
| Description | N’000 |
|---|---|
| Adjusted Profit/Assessable Profit | 78,750 |
| Capital Allowances | 15,155 |
| Total Profit | 63,595 |
| Companies Income Tax (30%) | 19,078.5 |
| Tertiary Education Tax (2%) | 1,575 |
2019 Assessment Year
| Description | N’000 |
|---|---|
| Adjusted Profit/Assessable Profit | 78,750 |
| Companies Income Tax (30%) | 23,625 |
| Tertiary Education Tax (2%) | 1,575 |
Additional assessments follow the same format, adjusting for capital allowances and applicable tax rates each year through 2023.
- Topic: Tax Administration and Dispute Resolution
- Series: MAY 2018
- Uploader: Dotse