- 18 Marks
Question
Red flow Ghana Limited is a manufacturing entity in Ghana. Mr. Kurt Wildem, a citizen and resident of Germany owns 90% of the company’s shares. Mrs. Florence Wildem, a citizen and resident of Germany and wife of Mr. Wildem also owns 5% of the shares of the company. Mr. Jogen Wildem, the son of Mr. Kurt Wildem holds the remaining 5% of the shares in the company. As of 1st June 2019, the company had a stated capital of GH¢400,000.00. A report submitted by the management to the Board of Directors indicated that the company needs to acquire a plant valued at GH¢1,000,000.00 to enable the company to increase its production capacity. Mr. Kurt Wildem who is the majority shareholder has offered to finance the purchase of a 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. Kurt Wildem on i. the income tax treatment of providing the asset to the company as equity contribution. (7 marks) ii. the income tax treatment of providing the asset to the company as a loan. (7 marks) iii. the preferable option for providing the asset to the company in order to derive the maximum tax benefits.
Answer
i. Income Tax Treatment of Providing the Asset as Equity Contribution
- The returns a person receives for holding equity in a company is dividend. (See definition of dividend in section 133 of Act 896)
- Dividend is not deductible for tax purposes. (See section 130(4) of Act 896)
- Dividend paid is subject to a withholding tax of 8%. (See section 115 and First Schedule to Act 896)
- Where a company which is controlled by not more than five persons and their associates does not distribute to its shareholders as dividends, a reasonable part of the income of the company, the Commissioner-General may treat any part of the company’s profit as dividend after considering the current business requirement of the company and any other requirement necessary for the maintenance and development of the business. (See section 59(8) & (9) of Act 896).
ii. Income Tax Treatment of Providing the Asset as a Loan
- The returns on a loan or debt obligation is interest. (See definition of interest in section 133 of Act 896)
- Interest paid on debt obligations which is employed in the business or used to purchase an asset which is employed in business is generally deductible for tax purposes thereby reducing the chargeable income on which tax is imposed. (See section 10 of Act 896)
- Interest on debt paid to an individual other than interest paid by a resident financial institution is subject to a withholding tax of 1%. (See section 115 and the First Schedule to Act 896)
iii. Preferable Option for Financing the Acquisition of the Asset
Since dividend paid by a company is not deductible for tax purposes, treating the contribution of the asset as equity will not reduce the corporate tax exposure of the company. In addition, the dividend Mr. Wildem will receive based on his equity in the company will attract a tax of 8%. On the other hand, if the asset is provided to the company in the form of a loan, the interest paid on the loan will reduce the chargeable income of the company thereby reducing the corporate income tax. The interest paid will also be subject to a withholding tax of 1%. It is thus preferable for Mr. Wildem to provide the asset to the company as a loan.
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