- 6 Marks
Question
a) The current level of government borrowing has become a topical issue for discussion, causing observers to wonder whether borrowing is good or bad. In the light of this, you are required to:
Below is the capital structure of Nyameke Ghana Limited for the 2014 year of assessment:
| GH¢ | |
|---|---|
| Equity | 20,000,000 |
| Loans | 80,000,000 |
| Total | 100,000,000 |
The loans were taken by Nyameke Limited from the parent company based in Nigeria. During the year under review, the subsidiary paid GH¢700,000 as interest on the loan and also incurred an exchange loss of GH¢500,000 on the repayment of a loan taken earlier from the parent company.
Required:
Determine how the above transaction will be treated for tax purposes. (6 marks)
Answer
This is a case of interest and foreign exchange loss being subjected to thin capitalization rules. The thin capitalization rules typically limit the amount of interest that can be deducted for tax purposes based on a prescribed debt-to-equity ratio.
- Thin Capitalization Ratio: The prescribed debt-to-equity ratio is 2:1. This means that the allowable debt is twice the equity amount.
- Calculation of Allowable Debt:Allowable Debt=2×20,000,000=40,000,000 GH¢\text{Allowable Debt} = 2 \times 20,000,000 = 40,000,000 \text{ GH¢}
- Interest Deductibility: Since the total debt is GH¢80,000,000, only GH¢40,000,000 is allowed for tax purposes. The interest that can be deducted is proportional to the allowable debt.Interest Allowed=(40,000,000×700,00080,000,000)=350,000 GH¢\text{Interest Allowed} = \left(\frac{40,000,000 \times 700,000}{80,000,000}\right) = 350,000 \text{ GH¢}
- Interest to be Disallowed: The remaining interest of GH¢350,000 (GH¢700,000 – GH¢350,000) is disallowed.
- Withholding Tax on Interest: The withholding tax on the total interest of GH¢700,000 at 8% is:Withholding Tax=700,000×8%=56,000 GH¢\text{Withholding Tax} = 700,000 \times 8\% = 56,000 \text{ GH¢}
- Foreign Exchange Loss: The allowable foreign exchange loss is also proportional to the allowable debt.Allowable Foreign Exchange Loss=(40,000,000×500,00080,000,000)=250,000 GH¢\text{Allowable Foreign Exchange Loss} = \left(\frac{40,000,000 \times 500,000}{80,000,000}\right) = 250,000 \text{ GH¢}
- Foreign Exchange Loss to be Disallowed: The remaining GH¢250,000 (GH¢500,000 – GH¢250,000) of the foreign exchange loss is disallowed.
Summary:
| Item | Total (GH¢) | Allowable (GH¢) | Disallowed (GH¢) |
|---|---|---|---|
| Interest | 700,000 | 350,000 | 350,000 |
| Foreign Exchange Loss | 500,000 | 250,000 | 250,000 |
| Withholding Tax on Interest | 56,000 | – | – |
- Topic: Business income - Corporate income tax
- Series: NOV 2016
- Uploader: Dotse