Durban Dry Distillers (Pty) Ltd (a South African resident) is a registered vendor for value-added tax (VAT) purposes and all
• 69% by Porkeater (Pty) Ltd, amounts in the question exclude VAT, except where indicated otherwise. Durban Dry Distillers (Pty) Ltd ('DDD') manufactures ('distils') and bottles gin, an alcoholic drink flavoured with juniper berries. The distilling process is regarded as a process of manufacture for purposes of the Income Tax Act. DDD sells the bottled gin to independent retail outlets. The company's year ends on the last day of December. Its equity share capital is held to the extent of -
• 16% by Derik Stretton, and
• 15% by Joseph Seagram.
DDD owns a number of investments, including dividend-yielding shares. It also deals in certain shares (see note 3). DDD had a profit before tax of R5 million for the year of assessment ended 31 December 2009. DDD did not have an assessed loss (as envisaged in section 20 of the Income Tax Act) or an assessed capital loss (as envisaged in paragraph 9 of the Eighth Schedule to the Income Tax Act) for the 2008 year of assessment. DDD would like to minimise its normal tax liability whenever possible. The profit before tax of R5 million was calculated taking into account the following items of income and expenditure:
Description
Note
Expenditure
Income
R
R
Sales of gin
450 000 000
Cost of sales of gin
7
443 379 950
Impairment loss - second-hand plant
1
30 000
Finance charges - replacement computer
2
4 200
Depreciation - all assets
449 725
Impairment loss - destroyed computer
2
31 500
Insurance payment received
2
56 000
Net gain on sale of shares
3
79 900
Gain on sale of laboratory land and buildings
4
705 000
Loss on disposal of laboratory equipment
4
8 000
Donation to university
4
80 000
Research expenditure - revenue
4
1 402 000
Finance charges - share acquisition
5
60 000
Dividend income - local
5
13 000
Dividend income - foreign
5
15 000
Impairment loss
5
54 000
Loss on disposal of factory land and buildings
6
338 125
Amortisation of operating lease premium and rentals
6
31 400
2
Total
445 868 900
450 868 900
3
Additional information (notes) 1 Second-hand plant On 1 September 2007 Porkeater (Pty) Ltd purchased a new manufacturing plant that it used in its distilling process for a cash cost of R200 000. It was brought into use immediately. This plant qualified for the 'accelerated' section 12C allowance. Porkeater (Pty) Ltd's year of assessment ends on the last day of December. On 31 August 2009 Porkeater (Pty) Ltd sold this plant to DDD for R250 000. This plant was independently valued at a market value of R220 000 on 31 August 2009. DDD brought the plant into use in its process of manufacture on 1 September 2009. The R250 000 cost of the plant was capitalised for accounting purposes. It was, however, then immediately impaired to its market value of R220 000. 2 Computer equipment DDD's computer equipment qualifies for the section 11(e) allowance over a five-year period (in terms of Practice Note 19), calculated on the straight-line basis. Computer equipment that originally cost R90 000 on 1 January 2006 and had a tax value of R36 000 on 31 December 2008 was destroyed by a power surge on 31 March 2009. DDD received R63 840 (including VAT) from its insurers as compensation for the loss of this computer equipment. The above computer equipment was replaced by new computer equipment that would have cost R84 000 (excluding VAT) had it been purchased for cash. It was, however, purchased under a suspensive sale agreement entered into on 1 June 2009. The terms of this agreement were payment of a deposit of R27 000 and 15 instalments of R4 400 per month. This computer equipment was brought into use on 1 June 2009. The first instalment was paid on 30 June 2009. This computer equipment was acquired to replace the damaged computer equipment. 3 Share-dealing transactions On 1 January 2009 DDD had in its opening stock of its share-dealing business amongst others the following:
• 1 000 shares in Sapphire Gin Ltd, a local listed company, valued at R8 000 for accounting purposes (original cost was R9 000); and
• 2 000 shares in Bombay Dry Plc, a foreign listed company, valued at their original equivalent cost of R12 000.
On 1 January 2009 the Sapphire Gin Ltd and the Bombay Dry Plc shares had all been held by DDD for exactly 30 months. The following transactions then occurred:
• On 31 March 2009 DDD sold all 1 000 shares in Sapphire Gin Ltd for R6 900.
• On 30 September 2009 DDD sold 1 500 of the Bombay Dry Plc shares for R90 000. On 31 December 2009 DDD still held 500 shares in Bombay Dry Plc. (Each Bombay Dry Plc share had a market value of R70 on 31 December 2009.)
It should be noted that no dividends were received by or accrued to DDD from either of these shareholdings during its 2009 financial year. 4 Research and development On 1 July 2007 DDD set up its own research and development division in an attempt to discover novel and practical information relating to potential health benefits (or problems) caused by drinking alcoholic drinks. This research and development division was initially located in a leased building.
On 1 September 2007 DDD commenced with the erection of its own laboratory building. The building was completed on 29 February 2008 at a total cost of R2 million, of which R1 200 000 was incurred before 31 December 2007. The building was brought into use on 1 March 2008. The building was erected on land that had been purchased by DDD on 1 July 2005 for R200 000. On 1 March 2008 DDD installed equipment in the laboratory at a cost of R480 000. The equipment was brought into use immediately. On 1 April 2008 DDD moved its research and development division out of the leased building into the new laboratory, where it continued with its scientific research.
On 1 January 2009 additional equipment costing R240 000 was purchased and installed in the laboratory. It was brought into use immediately. On 1 August 2009 DDD donated R80 000 to a recognised university for furtherance of scientific research connected with its trade. A section 18A certificate was issued by the university for this donation. On 30 November 2009 the research project was abandoned. On this date the laboratory, together with its equipment, was sold for R3 300 000. The sale and purchase agreement indicated that R2 500 000 was for the building, R300 000 for the land and R500 000 for the equipment. The following revenue expenditure was incurred by DDD in connection with its research activities:
R
1 July 2007 to 31 December 2007
1 120 000
1 January 2008 to 31 December 2008
1 200 000
1 January 2009 to 30 November 2009
1 402 000
5 Share investments and dividends On 1 January 2009 DDD borrowed R500 000 at 12% per annum. No portion of this loan was repaid during its 2009 year of assessment. DDD used the proceeds from this loan as follows:
5
• R200 000 was used to purchase local dividend-yielding listed shares; and
• R300 000 was used to purchase foreign dividend-yielding listed shares.
From these shareholdings the following dividends accrued to DDD during its 2009 year of assessment:
• Local dividends of R13 000; and
• Foreign dividends, being the equivalent of R15 000. No portion of these foreign dividends is exempt from tax.
The two dividend-yielding investments were included in DDD's assets in its statement of financial position at their current market value of R446 000. The R54 000 decrease in the value of DDD's investment in these two dividend-yielding share investments was recognised as an impairment loss. 6 Factory buildings and improvements to leasehold property On 1 May 2006 DDD purchased a plot of land for R750 000. Erection of a factory on this land commenced on 15 May 2006. It was completed on 30 September 2006 at a cost of R1 750 000. This factory was brought into use in a process of manufacture on 1 October 2006. As a result of continued unrest in the vicinity of this factory, the board of directors of DDD decided on 1 July 2009 to dispose of the land and buildings as soon as practically possible. The land and buildings were sold to an unrelated party on 31 October 2009 for R2 million, of which R300 000 was for the land and R1 700 000 for the buildings. DDD continued to use the land and buildings in its process of manufacture for the period 1 July 2009 to 31 October 2009. In anticipation of the proposed sale, DDD on 1 July 2009 entered into a 30-year operating lease agreement with Tanqueray Ltd for the lease of an industrial site in a trouble-free area. This lease agreement stipulated that DDD would -
• pay a premium of R84 000 on 1 July 2009;
• erect a factory on the site at a cost of R2 670 000; and
• from 1 July 2009, pay an annual rental in advance of R60 000 a year (subject to an annual escalation of R3 000 each year).
Erection of the factory commenced on 1 August 2009. It was completed on 31 October 2009. The factory was brought into use on 1 November 2009. The cost of the factory was R3 204 000. 7 Purchase of raw materials On 22 December 2009, DDD actually incurred an expense when it purchased 1 000 litres of alcohol (a raw material) for R190 000 on credit from a Johannesburg-based supplier. The alcohol was air-freighted to Durban on 24 December 2009, but cannot be found and it will not be possible to conduct a search for it before 31 December 2009 as the port is closed for the holiday season. As it is not trading stock held by DDD on 31 December 2009 (a requirement of section 22(1) of the Income Tax Act), it has been excluded from DDD's closing stock of raw materials.
6 Accounting treatment For reasons of prudence, the company has expensed R190 000 incurred on purchasing this alcohol (raw materials) as cost of sales. No transfer to work in progress has taken place because no portion of these raw materials has yet been used. DDD's closing stock of raw materials excludes these 1 000 litres of alcohol.
REQUIRED
Calculate the taxable income of Durban Dry Distillers (Pty) Ltd for the year of assessment ended 31 December 2009. Your calculation should start with profit before tax amounting to R5 million.