Discuss, with reference to legislation, (a) which deductions are available to Panda Flooring (Pty) Ltd in respect the costs incurred by the company for each of the floor sealants for the 2023 year of assessment and (b) whether the amount paid to Charlie Ireland, as compensation for his inability to work, will be included in his gross income for the 2023 year of assessment.

 

Relevent information

"Panda Flooring (Pty) Ltd ('Panda Flooring' or 'the company') is a business based in Epping,Cape Town that specialises in the design, supply and installation of high quality bamboo flooring.Panda Flooring targets the middle to high-end consumer market and has a financial year ending31 March. The company is a resident for South African tax purposes.
You have recently been appointed as the Tax Consultant of Panda Flooring. The companyprovided you with the following information relating to its 2023 year of assessment.

1. Possible investment opportunities for Panda FlooringDuring April 2022, the company's management indicated that it has a capital amount ofR950 000 that it wishes to invest for the next five years. Management is aware of the followinginvestment opportunities and would appreciate your advice regarding the most tax beneficialoption for the company:

Interest income bearing opportunities:

The Chief Financial Officer, Shaun Widget, has recently come across the following two savingsaccount options whilst browsing on the Standard Bank website:

1. Business Fixed Deposit Account1

This savings account allows the company to deposit the R950 000 lump sum and to earninterest of 10.50% per annum over a five-year period. Panda Flooring will withdraw theinterest income earned at the end of each year. There are no monthly fees payable onthis fixed deposit account and the capital is only accessible at maturity date.

2. Tax free investment Account2

This investment account allows certain taxpayers to save as much as R36 000 perannum, which will be regarded as tax free savings. Interest income is calculated as 7.75%per annum and funds are accessible immediately without any notice period required.This account also has no monthly fees due and payable.
Management is, however, not sure if this type of investment is available to juristic personsand has asked you to please include this as part of your overall consideration
Dividend income bearing opportunities:
The following two dividend income opportunities are currently available at a cost of R950 000each:

3. Investment in Zats Creations (Pty) Ltd

Panda Flooring wishes to acquire a 10% shareholding in Zats Creations (Pty) Ltd ('ZatsCreations'), a resident company for South African tax purposes. Zats Creations has
promised to declare a constant dividend of R257 500 per annum for the next five years.Panda Flooring will be able to sell the shares in Zats Creations for R1 360 000 at the endof the five-year period.

4. Investment in Foreign Stars (Inc)

Panda Flooring wishes to hold a 7% shareholding in Foreign Stars (Inc), a non-residentcompany for South African tax purposes. Foreign Stars (Inc) has promised that PandaFlooring will receive R204 600 per annum (correctly converted to ZAR) into thecompany's bank account in each of the next five years. This amount is net of the 12%
foreign dividend withholding tax charged in the foreign country.
Panda Flooring needs to incur an annual transaction fee of R1 400 to earn theabovementioned foreign dividend income. Panda Flooring will be able to sell the shares in Foreign Stars (Inc) for R1 250 000 (correctly converted to ZAR) at the end of the five-year period.

2. Fee Structure

Panda Flooring requires its customers to pay an upfront deposit of 50% of the contract pricebefore any work will begin on their order. Once this deposit has been received, Panda Flooringwill acquire the necessary raw materials and begin the design and installation work. Once theinstallation is complete, customers are required to pay the outstanding 50% of the contract price.Panda Flooring's accountant, Kaleb Cooper ('Kaleb'), has heard that the deposits may need to
be included in the gross income of Panda Flooring. Kaleb knows that the determination of thetreatment of the deposit for income tax purposes will depend on whether Panda Flooring holdsthe deposits in an attorney's trust account or uses the deposit as part of the company's networking capital (used to fund the company's operations).


3. Equipment Malfunction

On 30 November 2022, the pneumatic hammer3 used by Charlie Ireland ('Charlie'), an employeeof Panda Flooring, malfunctioned during the installation process. This resulted in serious injuries being sustained which led to Charlie being unable to continue working. On 31 January 2023,after the results of an internal inquiry into the event found that Charlie was not operating themachinery outside of its normal parameters, Just Hammers (Pty) Ltd (the manufacturer of thepneumatic hammer) decided to pay Charlie an amount of R350 000 as compensation for hisinability to work at Panda Flooring for the foreseeable future. This amount was paid to him on25 February 2023.
 

4. Asher Prince

Asher Prince ('Asher'), originally from Beijing, is a South African citizen and has been living inCape Town for the past 20 years. He is the Head of Operations at Panda Flooring. He is awidower and has an 18-year-old daughter, Lexi, who finished high school at the end ofDecember 2022. In Cape Town, Asher currently rents a 2-bedroom apartment, owns a motorcar and earns dividend and interest income from his investments in a few JSE-listed companies.On 31 May 2022, Panda Flooring decided to send Asher on a two-year secondment to thefactory in Beijing and fully sponsored his subsistence and accommodation. Planning hisdeparture on 1 July 2022, Asher cancelled the current rental of his apartment as he intends tolook for an apartment to buy on his return to Cape Town from secondment.When Asher left on secondment, Lexi moved in with her maternal aunt until she finished highschool. In January 2023, Lexi turned 19 and received a fully paid sponsorship from PandaFlooring to become a medical doctor. The sponsorship paid for her university tuition andaccommodation for 7 years until she qualified, which she accepted. She started her tertiarystudies at the beginning of February 2023 and settled in very quickly.Now that Lexi was settled in at university and Asher was enjoying being around his family inBeijing, he was considering lengthening his stay in Beijing by another year. He sent an email toJenna Wallis ('Jenna'), the head of the HR department at Panda Flooring, to ask what the normaltax consequences would be if he worked for Panda Flooring from Beijing until he was ready tocome back to South Africa. Asher does not intend to sell his South African investments. Jenna(not being a specialist in tax), has emailed you to provide an answer to Asher.

5. Agreement between Panda Flooring and Fancy Hotel Inc.Panda Flooring had 5 months to fill an order for one of its largest customers, a hotel chain calledFancy Hotel Inc. The project completion date is 1 March 2023. However, the flooring was heldup in customs which resulted in one month's delay in the completion of the project in SouthAfrica.
Per the agreement between Panda Flooring and Fancy Hotel Inc., Panda Flooring would incur apenalty of R10 million for any delay in the project completion date.Due to the time sensitivity, Panda Flooring contacted customs officials both locally and in Beijingto find out if there was any way of expediting the delivery of the order to the company'swarehouse with sufficient time to complete the project.Both officials indicated that there may be a way to expedite the delivery, however, it would cost
Panda Flooring a total of USD 22 000 (USD 6 000 for the local customs official and USD 16 000for the Beijing official, which includes a potential USD 9000 penalty charged by the state ofBeijing should the expedition be identified and reported). Panda Flooring decided to consult withtheir legal department before going ahead with payment, as something did not seem right.


6. Floor sealants
The company has two types of floor sealants.The first was developed by Panda Flooring in2019 at a cost of R150 000 and the patent for the second sealant was purchased from acompetitor, who went bankrupt, for R250 000 on 1 December 2022. The patent of the firstsealant (currently used in the installation of customers flooring) was registered by PandaFlooring on 1 April 2019 and extended at a cost of R40 000 on 1 April 2022. The patent for thesecond sealant was due for extension at a cost of R42 500 on 1 January 2023 and rolled out tocustomers on 1 February 2023.

ADDITIONAL INFORMATION:

• Assume that there will be no further changes to the corporate tax rate in future years ofassessment beyond those already announced.

• Assume that a discount rate of prime + 5% applies to all investment opportunitiesconsidered by Panda Flooring."