KASNEB Advanced Taxation - Question 4a

Highlight four factors to be considered when selecting an appropriate transfer price. ... [Click to view full question and step-by-step solution]

November 2015

1a

Public sector procurement

A recent study on public financial management in developing countries identified a growing interest by governments to establish and enhance public private partnerships (PPPs) as one of the ways of achieving sustainable development. In some of the countries covered by the study, a public private partnership (PPP) unit had been established within the mainstream government structure.

Required:

(i) Explore three possible reasons for the growing interest in public private partnerships particularly among developing countries.

(ii) Explain three functions of a public private partnership unit as established by a government.

(iii) Summarise three challenges likely to face the implementation of public private partnerships in your country.

1b

Management of Public Debts in both National and County Governments’

Country X has undertaken a number of infrastructural projects as part of its long-term development initiatives. This has however resulted in the government borrowing heavily from both the domestic market and the foreign market. As a result, interest rates have risen significantly, a situation that has affected other critical sectors of the country's economy.

Required:

In the context of the above scenario, advise the government of Country X on four approaches that it could use to manage its public debt.

1c

Public Financial Management Reforms in Kenya

In the context of monitoring of public projects by public entities, outline three objectives of electronic project monitoring information systems (e-PROMIS).

2a

Introduction to Public Financial Management

In recent times, public financial management has generated a lot of interest from governments, the public, donors among other stakeholders.

Required:

Discuss four distinctive features of financial management in the public sector as compared to the private sector.

2b

Public Sector Investment and enterprise management

According to legislation on investment promotion, an applicant may apply for an investment certificate from a public investment board.

Required:

In the context of the above statement:

(i) Outline three conditions that an applicant is required to fulfill in order to obtain an investment certificate.

(ii) Describe five areas that could be considered by the public investment board before grant of an investment certificate.

2c

Management of Public Debts in both National and County Governments’

Citing two examples, discuss the relevance of the international financial market in the context of public financial management in your country.

3

Taxation of business income and specialized business activities

James and Katana established a partnership business, sharing profits and losses in the ratio of 3:2 respectively. The following is the income statement of the partnership for the year ended 31 December 2014:

	Sh.	Sh.
Sales		6,728,000
Unrealised foreign exchange gain		150,000
Capital gain on sale of shares		352,000
Recovery from insurance on stock stolen		480,000
Goods transferred to a branch at cost		184,000
Dividends from Kali Cooperative Society		51,000
		7,945,000
Less expenses:
Purchases	2,842,000
Purchase of computers	180,000
Partners salaries	720,000
Legal fees	680,000
Repairs and maintenance	568,400
Rent and rates	244,600
Interest on loan	166,200
General expenses	964,000
Motor vehicle expenses	840,000
Insurance	156,000
Preliminary expenses	262,800
Directors fees	600,000
Audit fees	148,200
Debenture interest	360,000
Travelling expenses	960,000	8,828,200
Net loss		(883,200)

Additional information:

1	The partnership was converted into a limited liability company by the name Kaka Ltd. on 1 October 2014. Incomes and expenses accrued evenly throughout the year unless otherwise stated.
2	Purchases and sales were inclusive of value added tax at a rate of 16%.
3	Closing stock was valued at Sh.1,840,000 while opening stock was at 10% of sales net of value added tax.

4	Legal fees comprised:	Sh.
	Petition to Association of Manufacturers	80,000
	Notice for change of business name	64,800
	Conveyance fees of business	72,400
	Premises Stamp duty	36,600
	Negotiating a business loan	20,800
	Recovery of bad debts	45,000
	Signing a 100-year lease agreement	128,400
	Purchase of partner's private residence - James	150,000
	Appeal against tax arrears	82,000
		680,000
5	Repairs and maintenance comprised:	Sh.
	Purchases of furniture	96,000
	Installation of neon sign	60,000
	Designing an office block	140,000
	Cost of partitioning office block	250,000
	Repainting of business premises	22,400
		568,400

6	General expenses included; registering of patent rights Sh.64,000, floatation costs Sh.48,000 and negotiating costs for an additional piece of land for business expansion at Sh.56,000.
7	Interest on loan includes interest on partners' capital of Sh.100,000 which was shared according to profit and loss sharing ratio.

Required:

(a) A statement of adjusted taxable profit or loss for the business for the year ended 31 December 2014.

Hint: Start with gross profit.

(b) Comment on the tax position of James, Katana and the company.

(c) Citing examples, advise James and Katana on two areas of tax avoidance that they could explore for the business.

4a

Taxation of cross border activities

Highlight four factors to be considered when selecting an appropriate transfer price.

4b

Limited companies

Mjengo Ltd. is in the real estate business. During the year ended 31 December 2014, the company acquired ten houses each at Sh.4,000,000 before incurring the following expenses:

10% interest on mortgage loan of Sh.10,000,000.
Conveyance fees for each house Sh.40.000.
Estate agent's valuation fees per house Sh.28,000.
Repairs undertaken for two houses Sh.44,000.
Cost of repainting the houses Sh.84,000.
The impairment loss of the houses was estimated at Sh.150.000.
Legal expenses amounting to Sh.36,000 were incurred in defending a title for a house with defective ownership documents.

Mjengo Ltd. sold each house at Sh.5.800,000. The cost for advertising the houses was Sh.160,000. estate agent's commission Sh.180,000, insurance Sh.72,000, valuation fees Sh.150.000 and legal fees Sh.148,000.

Required:

Determine the following:

(i) Transfer value.

(ii) Adjusted cost.

(iii) Capital gains tax.

(iv) Due date for filing of capital gains tax.

4c

Limited companies

Rigs Drilling Ltd. is a mining company dealing with petroleum products. During the year ended 31 December 2014, the following details were extracted from the company's financial statements:

	Sh."000"
Geological costs	84,680
Exploratory drilling costs	146,400
Acquisition costs	19,800
Lifting costs	12,600
Lease operating costs	64,780
Costs of refining crude oil	18,240
Oil and natural gas revenue	9,840,000
Depletion and depreciation	34,980
Share based compensation	24,670
General and administrative expenses	78,340
Reversal of litigation expenses	9,680
Finance expenses	6,400
Decommissioning costs	4,280
Drilling machines	18,300
Investment income	464,000
Impairment losses	5,680
Intangible drilling costs	3,420
Professional fees	2,600
Loan repayment	840
Tractor	1,500
Derivatives oil losses	480
Restructuring expenses	848
Forklift	1,800

Additional information:

1. Intangible drilling costs include Sh.420.000 for a well which failed to yield crude oil and was abandoned.

2 Restructuring expenses include Sh.582,000 paid to a consultancy firm that restructured the capital structure of the company.

3. Exploratory drilling costs include:

Plant and machinery Sh.4,800,000.
Erection of rigs and tankage Sh.1,600,000. Pipes and storage tanks Sh.9,480,000.
Factory building Sh.48,400,000.

4. Professional fees include Sh.800,000 for services provided by the general manager of the parent company.

Required:

A statement showing the taxable profit or loss for the year ended 31 December 2014.

5a

Taxation of cross border activities

Summarise three legal provisions relating to double taxation relief as applicable in your country.

5b

Limited companies

Lima Ltd. is a company incorporated in your country. The company controls 80% of the share capital of Shamba Ltd. which is also incorporated in your country. The following is a statement of comprehensive income of Lima Ltd. for the year ended 31 December 2014:

............................................................	Sh. "000"	Sh. "000"
Gross profit		59,220
Less:
Depreciation	4,872
Legal expenses	508
Loan interest	819
Electricity	378
Salaries and wages	9,387
Telephone	357
Patent royalties paid	756
Travel expenses	785	17,862
		41,358
Other income
Patent royalties received	2,772
Loan interest received	193
Dividend received from Shamba Ltd.	5,628	8,593
Net income		49,951

Additional information:

1	The loan interest paid included the following: Interest of Sh.285,000 relating to a loan acquired to purchase office equipment. Interest of Sh.258,000 relating to a loan used to acquire shares of Shamba Ltd.
2	Salaries and wages include passages of Sh.1,008,000 paid to a director who relocated to another country.
3	Travel expenses include Sh.155,000 paid to a new employee hired from a foreign country.
4	The loan interest received relates to a loan issued to an employee of the company to purchase a residential house.
5	Not included in other income was rent received of Sh.1,638,000 from one lease, gross of a loss of Sh.397,000 made on another lease.
6	An operating loss of Sh.189,000 had been carried forward for the previous eight years. This loss was included in salaries and wages expense as at 31 December 2014.
7	Royalties of Sh.145,000 were due for receipt as at 31 December 2014 but had not been recorded in the books.
8	Legal expenses included: Sh.176,000 paid on disposal of some property and equipment. Sh.48,000 incurred on debt collection. Sh.78,000 incurred on defending the company against a claim for breach of contract.
9	Patent royalties received were from Shamba Ltd. while those paid were to a Ugandan company.
10	Capital allowances for the year ended 31 December 2014 were agreed with the commissioner Sh.1,932.000.

Required:

A statement of adjusted taxable profit or loss for the year ended 31 December 2014.

5c

Tax investigations

Amos Akida, a businessman, is facing a tax investigation by the revenue authority which suspects that he has been under-declaring income for the four years from year 2011 to year 2014.

You are the head of a team from the revenue authority conducting an investigation on Amos Akida. He has submitted to your team records of his private and business assets and liabilities from I January 2011 to 31 December 2014 as shown below:

	1 January 2011	31 December 2011	31 December 2012	31 December 2013	31 December 2014
Assets and liabilities	Sh. "000"	Sh. "000"	Sh. "000"	Sh. "000"	Sh. "000"
Factory premises	48,000	54,000	56,000	52,000	54,000
Plant and machinery	24,000	25,000	38,000	34,000	36,000
Motor vehicle (commercial)	12,000	14,000	14,000	15,000	20,000
Inventory	4,600	5,200	9,000	10,000	8,000
Trade receivables	3,950	4,540	3,640	3,530	3,980
Private residence	8,240	14,600	14,600	14,600	14,600
Trade payables	7,280	8,640	9,420	8,360	7,890
Bank loan	10,900	10,000	9,870	7,640	9,840
Loan from a friend	800	700	600	870	640
Mortgage loan	3,780	3,780	3,780	3,780	3,780
Cash balance	3,400	5,400	3,600	3,760	4,670

Additional information:

1	The cash balance on 31 December 2012 included Sh.600,000 inherited from a relative on 30 August 2012.
2	His living expenses for each of the four years were as follows:

	Year ended 31 December:
	2011	2012	2013	2014
Living expenses (Sh.)	85,000	140,000	90,000	165,000

3	Interest on mortgage is at the rate of 15% per annum.
4	There were no disposals of non-current assets during the period under investigation.

Required:

Taxable income of Amos Akida for each of the four years ended 31 December 2011, 2012, 2013 and 2014.

Ignore capital allowances.

November 2015

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