CARMEN VENTER

WORKSHOPS FOR THE PGRAD DIP IN FINANCIAL PLANNING

6/15/2014

A COMBINATION OF PAST EXAM QUESTIONS AND PREP GUIDE FROM UFS

CAR[Type text] Page 1 Question 1 Jamie Cassidy approaches you for advice. He is starting up a new business and would like to know which business entity would be the most appropriate. He is going into an interior décor venture with his best friend Paul Tshidi. Paul and Jamie’s concerns are protecting personal assets against business creditors and the possible disposal of ownership of the entity, should such a situation arise. They have heard from their relationship manager at Better Bank that a Close Corporation is most suitable for their needs. Jamie and Paul have the following questions: 1.1The Association Agreement is quite clear that in the event of the death of the first dying, the surviving member shall be obliged to accept the nominated heir of the first dying as a replacement to the deceased member. However, several years later, a third member, Jude, is allowed ownership in the CC. The 3 members then enter into a Buy and Sell agreement on advice from Jude’s financial planner, who did not do a proper business, needs analysis. Explain the ownership implications upon the death of the first dying of the 3 members? (2)

A member of a CC can be bound by an association agreement that he/she has not signed. Consequently, a new member of a CC will be automatically bound by the terms of the existing association agreement even though the new member did not sign such an agreement (section 44(5) of the CC Act). Where there is an Association Agreement, this will take precedence over any subsequent agreements in the event of conflict. The 2 surviving members will therefore be forced to accept the nominated heir of the first-dying as a replacement member.

1.2 What would the position be if a buy-sell agreement is implemented for the CC but no reference to the wishes of the members contained herein are reflected in the Association Agreement? (4)

Section 35 of the CC Act is applicable. Subject to any other arrangement in an association agreement an executor of the estate of a member of a CC who is deceased, must transfer the deceased member’s interest only if consent is given by the remaining members. If consent is not given within 28 days subsequent to such a request by the executor, the executor shall sell this interest to the corporation, remaining members or any other person who qualifies for membership of the CC. The wishes of the members in terms of the buy-and-sell agreement may still be implemented on the death of a member, but only if consent is given by the remaining members. If the Association Agreement had mirrored/ratified the terms of the Buy/sell this consent is unnecessary. No risk then exists that the terms of the Buy/sell will not be implemented.

QUESTION 2 Where a trustee of a trust, which is a partner in a partnership, takes out a buy andsell policy on the life of an individual who is also a partner in the partnership, the policy will be: (a) deemed property in the trustee’s estate for estate duty purposes; (b) the policy will be deemed property in the individual’s estate for estate duty purposes; (c) the policy will be excluded from the trustee’s estate for estate duty purposes; or (d) the policy will be excluded from the individual’s estate for estate duty purposes. CORRECT

QUESTION 3 (WE DID NOT ADDRESS IN CLASS AS I DO NOT THINK THIS WILL BE RELEVANT FOR THE EXAM – BUT 711 STUDENTS – YOU NEED TO KNOW LONG TERMS INSURANCE ACT) Ms Lewis took out a buy-and-sell policy on the life of her business partner with Cheap Insurance Company Ltd. The premium on the policy is due on the first day of every month. She recently went on an extended holiday abroad and forgot to pay the premium for September 2010. On her return on

CARMEN VENTER [email protected] 2 25 September 2010, she realised that she had not paid the premium. The policy document states that the policy will be suspended immediately should the premium not be paid on the due date. The current policy benefit has been valued at R650 000 in terms of the insurer's rules and methods. Ms Lewis took a loan of R100 000 from Cheap Insurance and ceded the policy as security. Her monthly premium on the policy is R2 000. Ms Lewis contacts you urgently requesting advice on the effect of her failure to pay the premium on the policy. Advise her accordingly and advise her on how to proceed in respect of the policy. [8 Suggested Solution Section 52 of the Long Term Assurance act governs the process where there is failure in the payment of premiums. a- The Long Term Assurer must notify the policyholder of premiums not paid. b- Where there are 2 or more premiums at intervals longer than 1 month, policy will remain in force for a period of one month after the due date. c- If the premium is then not paid by the end of this period then: If the remaining value, after a debt due to the insurer and secured by the policy, of the policy is greater than one-half of the total premiums due during the period of 12 months commencing on the due date of the unpaid premium – then: The insurer must inform the policyholder of the amount of the remaining value and notify her that the policy will remain in force as above until-: the policy no longer has any value and then lapses the premiums are resumed, or the provisions of the policy are amended, in accordance with insurer’s rules so that policy becomes paidup, or is surrendered at the request of the policyholder and dealt with accordingly. Should Ms Lewis not be able to pay all arrear premiums prior to the one month waiting period – then we have to calculate as follows: Value of contract R 650 000 Debt due to insurer R 100 000 R 550 000 Monthly Premium R2000 x 12 = R24 000 / 2 = R12 000 R550 000 great than R 12 000 The insurer will then inform Ms Lewis of the remainder of this value until Ms Lewis decides whether she wants to repay premiums, surrender etc. or allow the value to exhaust Hence Ms Lewis should pay all outstanding premiums within the one month waiting period to avoid any unnecessary lapses.

QUESTION 4 Mr Veldt and Mr Woods are both shareholders in Nature Supplies (Pty) Ltd. The company wants to enter into a buy-and-sell agreement in terms of which the company will take out a buy-and-sell policy on the lives of Mr Veldt and Mr Woods. The company approaches you for advice. Advise the company of the effect and consequences for the company (including the tax consequences) should Mr Veldt or Mr Woods die and the buy and sell policy becomes payable to the company. Also inform them whether it will be possible for them to acquire the shares held by the deceased. Motivate your answer in full. [5] Suggested Solution 1. Estate Duty Implications A buy and sell policy owned by the company on any of their shareholders will have estate duty consequences for the shareholder concerned as they are lives assured. We would now need to look at the Estate Duty Act to determine if any exemptions apply

As per Section 3(3)(a)(i) of the Estate Duty Act: the one requirement which may present a problem for the exemption is: ‘ at date of death must be a partner’ – clearly the company is not the partner of the shareholder. The others..must be a person – met – intention to acquire the deceased share – met –

CARMEN VENTER [email protected] 3 premiums paid not by the deceased –met (although this can be argued as the company as the money as a result of their shareholding so who paid?).

So this section the exemption is already ruled out – then we look onto Section 3(3)(a)(ii) which is more applicable to company owned policies.

To satisfy this section 4 requirements must be met: 1. the policy was not affected by or at the instance of the deceased. 2. no premium on the policy was borne or paid by the deceased 3. no amount due /recoverable under the policy has been or will be paid into the estate of the deceased and 4. no such amount will be paid to or utilised for the benefit of any relative of the deceased or any person who was wholly or partly dependent for his maintenance or a family company in relation to the deceased.

Requirement 2 should not present problems in this case.

Requirement 1 Will the company be affecting the policy’ at the instance of’ the shareholders? The commissioner applies a very wide interpretation and if the deceased had any part in taking out the policy on his life – even by simply giving approval – the exemption may fall away. But at same time the Commissioner seems acceptable of the process involved ir: signature is required, medicals must be performed etc

Requirement 3 This will be easy to fulfill if there is no obligation on the company to pay the proceeds to the estate – but if they are purchasing shares are they not paying it into the estate? Problem

Requirement 4 If it is not a family company this does not present a problem but will it not be utilised for the benefit of the dependents – or is it being utilised for the benefit of the company to obtain the shares of the shareholder and the beneficiaries just receive the monies? There is thus no clarity as to whether the policy can be taken out without it being subject to estate duty. = although I believe that it will be estate dutiable and the company is liable for the payment thereof less premiums plus 6%.

2. Tax consequences if company is buying it’s own shares – the facts given sounds like a share buy back.

The definition of dividend in the Income Tax Act includes (in the event of the acquisition of shares ito the Companies Act) – this means that the purchase of its shares is a deemed dividend to the extent that it is not payable out of Contributed Tax Capital. The company would have to withhold 15% dividend tax from the shareholder

QUESTION 5 Two brothers each hold a 50% share in Two Brothers (Pty) Ltd. The company has a net asset value of R 2 000 000. Their financial advisor has suggested that they enter a buy-and-sell agreement funded by life policies. The brothers are concerned about any tax implications should they die and should the value of the share in the business then amount to less than the value of the policy on their respective lives (for example R800 000 each serve as full payment of their shares in the company in the event of one of them dying.) Advise the brothers on: a)any tax (not estate duty) implications: b)who will be liable for the tax payable; and c)the amount of tax payable

CARMEN VENTER [email protected] 4 [3]

a) If at time of death the policy proceeds exceed that of the value of the company and, the Commissioner is not satisfied that the intention was to buy the shares of the deceased, then the surviving partner will be deemed to have made a donation and will have to pay donations’ tax. Obviously the deceased would have disposed of assets and will attract CGT. Also do not forget that there will be STT at 0.25% b) The surviving partner will have to pay the donations tax and STT c) 2 000 000 – 800 000 = 1 200 000 – 100 000 exemption = 1 100 000 donation at 20% = 220 000 donation tax payable.

QUESTION 6 A buy and sell arrangement on Mr A and Mr B was implemented at the time that they were partners. The partnership had ended prior to Mr B's death. The buy and sell agreement as well as the policies funding the agreement are still in place. The policy that pays out on Mr B's death will free of estate duty. Is the statement true or false FALSE

Tom and Hank have been members of ABC CC for 15 years . Tom is considering selling his member's interest in the CC to Hank as, Tom is wanting to retire. Which costs/ expenses / taxes - will this transaction attract a: transfer duty and capital gains tax b: income tax, capital gains tax c: capital gains tax, securities transfer tax d: all of the above

In a buy and sell arrangement one should or can always include a loan account amount: a: irrespective of the business entity involve d b: only with a company c: with a company as well as a partnership d: only with a partnership

Bob and Sally have entered into a buy and sell arrangement with life insurance funding the agreement. They each have a 50% shareholding in the company which is valued at R 5 000 000. On Sally's death, the policy pays out an amount of R 7 500 000 for the purpose of this agreement.

Which of the following statement is false a: the transaction could attract donations tax b: the full amount of R 7 500 000 could attract estate duty c:There would be no donations tax and the amount that is dutiable is the difference between R5 000 000 and R 7 500 000 Where the shareholder is also the employee of the company and, the company is seen to be paying the premiums on behalf of the shareholder - this will attract a fringe benefit tax in the hands of the shareholder employee. True or false TRUE

Trustee Tom on behalf of the T OMMY Trust takes a policy on the life of Gavin in his individual capacity and Gavin takes out a policy on the life of Tom in his capacity as Trustee of the TOMMY Trust. The TOMMY Trust and

CARMEN VENTER [email protected] 5 Gavin are equal shareholders in GAVTO Pty Ltd. Which statement is true a The policy on the life of Tom will attract estate duty b The policy on the life of Gavin will attract estate duty c The policy on the life of Tom will not attract estate duty d none of the above

There are 3 shareholders involved in a buy and sell agreement. As a result, the premiums are collected from the company's bank account, the intention being that the loan account will be cleared on a regular basis -at least within a 2 year period. 5 years down the line nothing has been done. select the correct statements a: there is no adverse effect as long as the loan account Is cleared before a death occurs b:this could be deemed to be SHAREHOLDERS contributions and falls foul of the estate duty requirement c: You could be looking at possible fringe benefit d: You could be looking at possible dividend withholding tax e Policies will still remain estate duty exempt f Policies could be estate dutiable a and e a and d f and b and c b, c,d and f

In a company share buy back i e where the company buys back it's own share from it's shareholder, there will be an element of a capital gain as well as a dividend distribution in the hands of the shareholder true or false TRUE

If a company has 4 shareholde rs - all must be involved in the buy and sell agreement. The buy and sell agreement can only work if all agree to buy and or sell their relevant shareholding. true or false FALSE

It is of imperative importance that the Trust Deed, where a Trust is involved in a buy and sell agreement, allows for the selling of it's shares to 3rd parties. If this is not the case, the agreement will be difficult to enforce.

True or false TRUE

QUESTION 7 Mr Drag and Mr Trent are the only members of D & T CC. Each own a 50% interest in the CC which manufactures socks for sportsman and women. A financial advisor, suggested that they enter into a buy and sell arrangement. Both have existing policies on their own lives worth R2 million each – and they decided to use these policies to fund the buy and sell and subsequently cede these to one another. The buy and sell agreement obliges the other to buy the shares in the CC in the event of death. A clause is inserted in the agreement which states that the Executor of the deceased estate of the 1st dying will be obliged to ceded the policy on the survivor’s life to the survivor. Mr Drag dies 2 years later. An independent valuator values the Mr Drag’s interest in the CC to be R 4 million at time of death. Mr Drag’s net personal net estate was R10 million and he was married in community of property.

CARMEN VENTER [email protected] 6 7.1 Discuss the possible estate duty implication that may result, with reference to the estate duty act and state who will be liable for estate duty if any. (3)

Section 3(3)(a)(i) – requirement being that the deceased has not borne his own premium – so they cannot have paid their own premium. In ceding existing policies that they own means that they were paying their own premium and therefore they would fall foul of this requirement. The policies would thus not be exempt and fully estate dutiable and the surviving partner would be liable for the payment thereof.

7.2 Had you been the financial advisor, explain briefly if you would have structured the agreement and buy and sell funding between the parties any differently. Substantiate your answer. (3)

If we were to avoid having to take on new policies, then the existing policies would suffice with the exception that cover would be increased to cater for the estate duty that is payable.

7.3 On Mr Drag's death the executor will have to cede the policy on Trent’s life back to Trent as per the agreement. What are the possible capital gains tax implications on the proceeds of this policy when Mr Trent dies and the policy pays out? (3)

Para 55 of the 8th Schedule clearly exempts a policy where, partnership terminates, and is ceded back to the surviving partner if the policy was structured according to the exact requirements needed under Section 3(3)(a)(i) of the Estate duty act. No cgt would be applicable at the time of this transfer.

QUESTION 8 Abe and Bart are partners, and have drawn up a properly structured buy-and-sell agreement, funded by long-term policies. Under the arrangement Abe is the owner (payer and beneficiary) of a policy on the life of Bart and Bart is the owner (payer and beneficiary) of a policy on the life of Abe. The partnership is dissolved and the parties wish to retain the policies on their own lives. Abe cedes his policy to Bart and Bart cedes his policy to Abe. Advise on the CGT implications if any making reference to legislation

As with question 7 – Para 55 of the 8th Schedule states:

Disregard any gain or loss : (c): - iro a policy that was taken out to ensure against the death, disability, severe illness of that person by another person who was a partner, held shares etc, for the purpose of enabling that other person to acquire the deceased share in that company and, no premium on the policy was paid while that other person was the beneficial owner of the policy.

The above clause will exempt this transaction between Abe and Bart – and no CGT will be applicable.

KEYMAN

Question 1 A father and his son each hold a 50% member’s interest in a close corporation. The father is indispensable to the business. Should he die, a replacement will need to be found. (a) What solution is recommended? (b) What are the estate duty implications? (a) What solution is recommended to address (b)? [3]

a) The father is obviously a ‘keyperson’ in the business and therefore Keyman Insurance would be the recommended solution to address this need,

CARMEN VENTER [email protected] 7 b) Firstly, it would be dutiable as a result of the fact that he is a ‘life assured’. Then we would have to look at if the Estate Duty Act allows an exemption and, it does – Section 3(3)(a)(ii) does make keyman insurance exempt –but, it specifically excludes where it is family company in relation to the deceased – then it is not exempt. So the policy on the father will be dutiable and paid by the company. c) Increase the life cover to cater for duty..cover needed / 0.80

DEFERRED / PREFERRED COMPENSATION QUESTION 1 [am unable to copy paste the question – please refer to the Question paper.

This question was designed for the legislation at the time and hence all the information provided – but with the new legislation that has been effective from 1/3/2012 – the payout will be included in the employee’s income and will only be exempt under from income IF the premium paid by the employer was a FRINGE BENEFIT from the DATE OF COMMENCEMENT of the policy. If it was not a fringe benefit from doc – then it will not be exempt and will be taxed in the hands of the employee at his marginal rates.

QUESTION 2 If a policy was ceded to a director at retirement for no value in terms of a deferred compensation agreement: (a) the cession value will be included in the director’s gross income and any capital gain or loss on maturity of the policy will be excluded from capital gains tax; (b) the cession value will be included in the company’s gross income and any capital gain or loss on maturity of the policy will be excluded from capital gains tax; (c) the cession value will be included in the director’s gross income and any capital gain or loss on maturity of the policy will be excluded from capital gains tax if the premiums were deducted under section11(w); or (d) the cession value will be included in the company’s gross income and any capital gain or loss on maturity of the policy will be excluded from capital gains tax if the premiums were deducted under section11(w). [1]

NOTE: THE ABOVE QUESTION WAS PRIOR TO THE ‘RISK ONLY’ EXEMPTION UNDER PARA 55 OF THE 8 TH SCHEDULE

QUESTION 3 Profitable (Pty) Ltd is considering implementing a deferred compensation scheme for two of their employees as well as keyman assurance iro Jack Jones. The company would like to maximise the income tax deduction for itself as well as the benefits payable to the 2 employees iro the deferred compensation. How would you recommend the keyman and deferred compensation policies be structured?

If this is for the company to take advantage then they are looking at tax deductibility. So they have to comply with 11w(i) requirements for the deferred endowments and 11w(ii) for the keyman policy.

CARMEN VENTER [email protected] 8 For the deferred endowment – it has to be a fringe benefit for the employee before the employer can make use of a deduction.

For the keyman policy it has to be risk only, on the life of the employee for a loss in case of death, disability and /or severe illness – the company must benefit and not the employee, his estate, beneficiaries etc and the company must own the policy at all times. If ALL requirements met then they can make use of the tax deduction.

WHERE EMPLOYER BENEFITS – COMPANY OWNED QUESTION 1 Choose the correct statement. 1.1 The capital gain in respect of a company-owned policy disposed of by a director to whom the policy was ceded on his leaving the company’s employ, will be exempt from any capital gains tax if: (a) that person is or was a director whose life was insured in terms of the policy; (b) any premium paid by the company was deducted in terms of section 11(w); (c) that person is or was a director whose life was insured in terms of the policy and the premiums paid by the company were deducted in terms of section 11(w); or (d) that person is or was a director whose life was insured in terms of the policy and the premiums paid by the company were not deducted in terms of section 11(w). [1]

AGAIN – QUESTION BEFORE RISK ONLY EXEMPTION UNDER PARA 55 OF THE 8TH SCHEDULE.

1.2 If a loan is obtained against a company-owned policy on the life of an employee, from the life insurer itself: (a) the loan amount will be included in the company’s gross income but the premiums will be deductible; (b) the loan amount will not be included in the company’s gross income and the premiums will not be deductible; (c) the loan amount will be included in the company’s gross income but the premiums will not be deductible; or (d) the loan amount will not be included in the company’s gross income and the premiums will be deductible. [1]

RESTRAINT OF TRADE Jenean, a sole proprietor sold her business on condition that she may not open a new business within a radius of 50 kilometres, within a period of 2 years. She received a restraint of trade payment of R220 000. Briefly explain the tax consequences of this payment for both the payer and for Jenean the receiver. [2]

R220 000 in total will be included in Jenean income and taxed as per the marginal rates.

For the company deduction will take place on term of trade or 3 years whichever is longer. So 3 years is longer = 220 000 / 3 = the amount able to deduct over the 3 year period.

CARMEN VENTER [email protected] 9