- 10 Marks
Question
Exclusif Homes Ghana Ltd is a wholly owned Ghanaian real estate company. The basis period of the company ends on 31 December each year. The company has obtained a government contract to build low-cost houses across the country. In order to raise additional capital to undertake this project, the company is looking for an investor who would acquire at least 51% of the shares of the company. The managers of the company are engaged in negotiations with several potential investors, and there is the likelihood of having an investor and agreements signed on 31 January 2022.
The financial statements of Exclusif Homes Ghana Ltd revealed that the company made a loss of GH¢2,500,000 for the period ended 31 December 2021. Included in the expenses of the company are financial costs and bad debt amounting to GH¢100,000 and GH¢150,000 respectively.
The company also has a parcel of land located at Abokobi which the company purchased three years ago at the cost of GH¢100,000. The current value of the land is GH¢500,000.
Required:
Advise Exclusif Homes Ghana Ltd on the following:
- The income tax implications for the company if an investor acquires 51% of the company’s shares and the tax planning opportunities available which could reduce the income tax exposure of the company if an investor acquires 51% of the company’s shares.
- Measures the acquirer can adopt to mitigate the tax effects (if any) of the proposed transaction.
Answer
- Income tax implications and tax planning opportunities:
- Change in underlying ownership:
If an investor acquires 51% or more of the company’s shares, this will result in a change in underlying ownership as per Section 62(1) of Act 896. When there is a change of more than 50% in the underlying ownership of a company within a three-year period, the assets and liabilities of the company are deemed to be realized immediately before the change. - Deemed realization of assets:
Section 42 of Act 896 provides that if there is a change in underlying ownership, the assets of the company will be deemed realized at their market value. In this case, the land at Abokobi, which has appreciated from GH¢100,000 to GH¢500,000, will be considered realized, resulting in a gain of GH¢400,000, which will be subject to a 25% tax on the gain.
(3 marks) - Losses and financial costs:
Section 62 of Act 896 further stipulates that when there is a change in ownership exceeding 50%, the following consequences arise:- Financial costs carried forward (GH¢100,000) incurred before the change cannot be deducted.
- The loss of GH¢2,500,000 incurred before the change cannot be carried forward for tax deduction.
- Any unrealized gains on the company’s assets (e.g., the GH¢400,000 gain on the land) will be taxed.
(2 marks)
- Tax planning opportunity:
The company could explore the possibility of spreading the sale of shares over a period longer than three years to avoid triggering the tax implications of a change in underlying ownership. Alternatively, it could negotiate to structure the investment as a loan rather than equity to avoid a change in underlying ownership and preserve the tax benefits associated with losses and financial costs.
(2 marks)
- Change in underlying ownership:
- Measures to mitigate tax effects:
- Staggered acquisition:
The investor could stagger the acquisition of shares to ensure that the change in ownership does not exceed 50% within a three-year period, thus avoiding the triggering of deemed realization rules and the loss of financial cost and tax loss deductions. This can be done by acquiring less than 50% of the shares initially and the remaining over the next three years.
(1.5 marks) - Loan financing:
Another strategy could be for the investor to provide financing to the company in the form of a loan rather than an equity investment. This would help the company avoid the deemed realization of its assets and the loss of carried-forward tax losses and financial costs while allowing the company to benefit from tax-deductible interest payments.
(1.5 marks)
- Staggered acquisition:
- Tags: Change in Ownership, Financial cost, Share Acquisition, Tax Loss, Tax Planning
- Level: Level 3
- Topic: Mergers, amalgamation, and reorganization
- Series: JULY 2023
- Uploader: Theophilus