STP – Feb 2007 – L3 – Q4 – Employee Loan Taxation

Advise on tax implications of a $300M loan and bonus for Dr. Ababio, including relevant Tax Act provisions.

Question

(a). Dr. Ababio discusses an engagement she recently accepted with an investment banker with you for advice. She indicates that one of the recruiting inducements that convinced her to accept the position is a $300M loan from her employer. She will receive the loan proceeds on her first day of work and must sign a note to repay the loan plus accrued interest in five equal annual installments.

The employer will forgive any amount of the unpaid debt if Dr. Ababio dies, becomes disabled, or is terminated from employment through no fault of her own. Dr. Ababio’s contract provides that the employer will pay an annual bonus equal to each loan repayment. The contract stipulates that the bonus must be applied to the repayment of her loan.

Required:
i) Advise Dr. Ababio on the implications, if any, of this engagement provisions.
ii) Discuss any three provisions in the Tax Act which will support the position the Commissioner will take in respect of the taxability or otherwise of this engagement provision.

(b). The Free Zone Act declares a 10-year tax holiday for Free Zone Operators. Sweet Entities Inc. desires to set up in the Free Zone enclave but requires an understanding of the practical tax concessions granted to free operators. To this effect, the Tax Director of Sweet Entities Inc. requires that you do a practical presentation of the flow of the corporate tax-exempt concession as extended to the operator. He therefore provides you with the following business forecast for the first 10-year period as follows.
All figures in $M

Year	1	2	3	4	5	6	7	8	9	10
Adjusted Profit	10	60	150	500	1,000	1,000	1,000	520	600	620
Capital Allowance	1000	600	300	150	50	20	20	600	340	200

Compute the tax position, if any, of Sweet Entities Inc. for the exempt period.

Answer

a)i.
a) Dr. Ababio receives a loan of $300M of which the principal and interest is payable each year. The payment of the loan and interest has no tax implications for Dr. Ababio.
b) The bonus payment of $60M made to Dr. Ababio each year attracts a bonus tax of 5% on the first $16.5M and the remaining $33.5 will have to be added to her income and taxed every yearly period.
c) Alternatively, the IRS may decide to tax the entire $300M bonus in the first year of receipt since the entire payment was received in the first year of employment.

ii. Sec. 8 (3) of the Internal Revenue Act indicates that, for purposes of ascertaining income from employment, any amount, allowance, or benefit is a gain or profit from employment if it
a) Is provided by the employer, an associate of the employer, or a third party under an arrangement with the employer or an associate of the employer
b) Is provided to an employee or an associate of an employee; and
c) Is provided in respect of past, present, or prospective employment.

This provision enables the Internal Revenue Service to tax the loan extended to Dr. Ababio since this loan could be seen as an upfront payment of a five-year bonus. The IRS will then be right in assessing the bonus payment to tax on the day of receipt or as and when earned.

(b). All Figures in $M

Year	1	2	3	4	5	6	7	8	9	10
Adjusted Profits	10	60	150	500	1000	1000	1000	520	600	620
C. Allow. For year	1000	600	300	150	50	20	20	600	340	200
C,A b/f
Total	1000	1590	1830	1830	1380	400	20	600	420	200
Ch Income	0	0	0	0	0	600	980	0	180	420
Tax Payable	0	0	0	0	0	0	0	0	0	0
CCA c/f	990	1530	1680	1330	380

Tags: Apportionment Formula, Exempt supplies, Input Tax, Taxable Supplies, VAT
Level: Level 3

Topic: Strategic Indirect Tax Management
Series: FEB 2007

Uploader: Samuel Duah