In the world today, a cautious sense of relief is beginning to take hold as vaccines are increasingly being rolled out and the scourge of Covid-19 starts to take a back seat in the international news media. The world we are starting to imagine for the future can justifiably be dubbed, ‘post-Covid’.

As anyone in the professional world will be able to attest, the pandemic has fundamentally changed the environment in which we do business. This, in turn, has altered our investment decisions and the necessary checks and audits that need to be performed.

What is Financial Due Diligence

Due diligence is something that companies normally perform in order to avoid committing an offense and to ensure that they are operating within the boundaries of the law.

Similarly, financial due diligence (FDD) is the term used to describe an inquiry or investigation into a potential investment to confirm the facts that could significantly influence investment decision-making. The purpose of this could be for a merger or acquisition, issuing new shares, or any other transaction where risk is relevant and necessary to make a decision using reasonable care.

An FDD is commonly misunderstood as an audit. The key difference between them is that an audit looks back, while an FDD looks both backwards and forwards, to uncover vulnerabilities and opportunities, and to reveal a realistic future for the company.

The primary purpose of an FDD is an assessment of the financial health of a business.

What do we mean by “Financial Health”?

Financial health can be summarised in four main internal areas of a business:

  • Liquidity is the cash on hand that can be used by the business today.
  • Solvency compares the assets of a business to its liabilities to measure whether a company can meet its long-term financial obligations.
  • Profitability measures profit against revenue and costs, to give a broad overview of a business’s current financial position and viability. The gross profit, net profit and EBITDA margins are good indicators for understanding and strengthening profitability.
  • Operating efficiency measures operating costs against sales to show how profitably a business is serving its customers.

These four aspects taken together make up the overall health of the business, and they can be used as a measure of present performance and future success.

Why perform an FDD?

FDD’s are very useful, especially where investment transactions are concerned. For starters, investment transactions that undergo a due diligence process offer higher chances of success.

Due diligence contributes to making informed decisions by enhancing the quality of information available and identifying all material risks. Such risks will need to be managed should the acquirer proceed with the transaction.

The risks may also be used as negotiating power for the acquirer in determining the value at which the transaction takes place. Alternatively, if the risk is outside of the acquirer’s appetite, the process might result in an unsuccessful transaction.

A systematic process helps to ensure that buyers and sellers are on the same page. This helps to prevent any entity from unnecessary harm to either party throughout a transaction.

FDD’s Post-Covid shift

With market stability returning in what we are tentatively calling the ‘post-Covid era’, FDD’s focus has changed and there are new factors to consider in a business environment that is fundamentally different.

An FDD looks both backwards and forwards, and it is therefore useful for envisioning a realistic future for a particular company. FDDs will now need to assess how businesses responded to the pandemic and how they may have carried on differently. Investors may specifically consider new post-pandemic liabilities. Identifying a company’s ‘new normal’ – in other words, the way that it does business now and in the future – may be necessary.

Furthermore, we expect there to be a focus on areas such as supply chain risk, health and safety, financing arrangements and cybersecurity, given the accelerated digitisation in many sectors of the economy. A business’s digital capabilities will be of utmost importance.

Also, going forward, force majeure clauses in fundamental legal agreements will be relevant especially with the possibility of future waves of the pandemic.

In the current environment, we are seeing an increase in ‘quasi-distressed’ deals coming to the market which is where companies are needing to dispose of assets to support their core business post-pandemic.

While Covid-19 hasn’t changed the overall purpose of an FDD, it is important to assess the impact that the virus has had on the FDD process. It would be difficult to find even one company that has not been affected by the pandemic in some way, so it is only natural that financial and professional advice is needed now, more than ever.

If you think you might need professional assistance in assessing the risks of a potential investment transaction, contact Creative CFO for FDD support.

References

Arnoldi, M. (n.d.).   Pandemic has influenced due diligence priorities for M&A activity, says law firm. [online] www.engineeringnews.co.za. Available at: https://www.engineeringnews.co.za/article/pandemic-has-influenced-due-diligence-priorities-for-ma-activity-says-law-firm-2020-09-14/rep_id:4136

International, B. (n.d.).   Post-COVID Due Diligence. [online] blog.benchmarkcorporate.com. Available at: https://blog.benchmarkcorporate.com/post-covid-due-diligence

https://www.nortonrosefulbright.com/en-za/knowledge/publications/2021/q1. (n.d.).   Due diligence in the time of COVID. [online] Available at: https://www.nortonrosefulbright.com/en za/knowledge/publications/ce966575/due-diligence-in-the-time-of-covid

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While the pandemic has forced many employees to work from home, you may be wondering if you now qualify for the home office tax deduction. We outline the requirements for employees to qualify below.

Requirements to deduct home office expenses

  • You are currently employed and working for a salary / commission
  • You are required by your employer to work from home
  • You have an office / area that is used regularly and exclusively (more than 50%) for your work i.e. the kitchen counter would not suffice
  • Your office is specifically equipped for purposes of the trade e.g. fitted with a desk, computer and printer

What expenses can you deduct?

  • Rent
  • Interest on bond
  • Rates and taxes
  • Cleaning
  • Wear and tear
  • Repairs to the office
  • Other expenses relating to the office

Ifmore than 50% of your remuneration is comprised of commission you can also deductcommission related business expenses i.e. telephone, stationery, repairs to printer etc.

How to calculate home office expenses

If the expenses relate to the residence as a whole, the expense must be apportioned as follows:

A/B x total costs, where

  • A = The square metre area used for work
  • B = The total square metre area (including any outbuildings and the area used for work) of the residence
  • Total costs = the total costs incurred for the acquisition and upkeep of the property (excluding expenditure of a capital nature)

If the expense is a specific business expense then the entire cost is deductible.

2021 tax year 

If you have been working at home due to COVID-19 you will only be able to claim this deduction for the 2021 tax year if you will have worked from home for at least 6 months of the tax year and meet the requirements above.

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In response to COVID-19, SARS has re-designed the 2020 tax filing requirements for individuals.  Some material changes have been made to simplify the process and remove the need to visit SARS branches in an aim to become more efficient and observe social distancing.

Through the increased use of third-party data, SARS will be completing your tax return for you. Where SARS has the required information they will provide you with a proposed auto-assessment without the need for you to file a tax return. This enables you to view, accept, or edit your proposed assessment online using eFiling or SARS MobiApp.

The 2020 tax season (period 1 March 2019 to 29 February 2020) for individuals will open 1 June 2020 and it will be staggered as follows:

Auto-Assessments
1 June 2020 – 31 August 2020 SARS will issue auto-assessments based on third party data (e.g. employers, medical aid, pension funds, etc) and provided claims are not anticipated (e.g. travel allowance). Taxpayers have the opportunity to accept auto-assessments or not as per below:

  • During August auto-assessments will be issued and taxpayers will be notified by SMS
  • Taxpayers have the opportunity to confirm acceptance of the auto-assessment afterverifying the accuracy OR if you do not agree with the results or anticipate claims you can edit the information and resubmit your income tax return from 1 Sept
  • If you accept the auto-assessment under or overpayments will be processed as normal
  • Taxpayers who are NOT required to file will be informed – details to be advised
  • Taxpayers who are required to file from 1 Sept will also be informed – details to be advised
Filing 
1 Sept 2020 – 16 November 2020 Non-provisional taxpayer eFiling
1 Sept 2020 – 22 October 2020 Non-provisional taxpayer Branch filing by appointment
1 Sept 2020 – 29 January 2021 Provisional taxpayer eFiling

It is important to note that SARS will be relying on data collection from both local and international third parties.

Creative CFO welcomes this trend towards automation if it saves you time and money, and we see this as the first step towards future digital submissions. We are here to assist you in navigating these changes and make the most of the new technology.

If you have any questions please contact our Tax Team here.

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Drowning in tax debt? Don’t owe the South African Revenue Service (SARS) the tax liability they say you do? Perhaps you don’t even know whether or not you have a tax liability due.

Deciphering tax assessments and managing tax debt can be overwhelming. SARS does, however, provide resources and channels through which you can gain a better understanding of your tax compliance status and tax liability. In addition, you can make certain applications or requests to SARS to manage your tax liability. We break these all down for you here.

1.Understanding your tax status

In order to determine if you are up to date with your tax affairs, you can easily check your tax compliance profile via eFiling. We recommend that you do this regularly to ensure you have no outstanding submissions or payments which could result in the accrual of penalties and interest.

Non-compliance can result if you have outstanding tax returns which need to be submitted or debt that still needs to be paid. Creative CFO can assist by performing an analysis of your tax profile and providing you with a report of your tax compliance status.

On completion of the required tax submissions, SARS will issue yearly assessments (ITA34 for individuals and ITA34C for companies). These assessments depict the tax liability due, if any. If you do not understand how SARS derived this tax liability you can request reasons from SARS via eFiling within 30 days from the date of assessment.

2.Verification and audit

If SARS notify you that you have been selected for verification or audit please don’t panic! A verification is merely a face-value verification of the information declared in the return. An audit, however, is an examination of the financial information submitted to determine whether you have correctly declared the tax position to SARS. By its nature, an audit is a more extensive process than verification and the scope could be broader.

In both instances, it is important to ensure you submit the required information within 21 days of the SARS notice to avoid unnecessary penalisation.

3.Dispute resolution

Should you disagree with your assessment, you can object to SARS within 30 days from the date of the assessment (or from the date the written reasons are provided). The objection must specify in detail the grounds upon which it is made and must be in the prescribed Notice of Objection (ADR1) form. Creative CFO can assist you in compiling an objection in this prescribed form and submitting this to SARS.

Should SARS disallow the objection, taxpayers still have the right to appeal against such a disallowance.

4. Deferred payment or compromise of tax debts

If there is no disagreement about your tax liability but you are not in a financial position to settle the full amount owing immediately, you can request adeferred payment or compromise arrangement.

  • A deferred payment arrangement is essentially a payment plan with SARS to settle the debt. You are required to motivate your case and show a deficiency of assets or liquidity which will likely be remedied in the future. Creative CFO can assist you in motivating and preparing a deferred payment request.

  • A compromise is an agreement wherein the taxpayer will pay an amount which is less than the full amount owing, and SARS will write-off the remaining portion. This is a financially intrusive process and requires that the tax debt is considered uneconomical to pursue. Bear in mind that this is not a decision SARS takes lightly. Creative CFO can advise and assist you in preparing the request for a compromise of tax debt.

If you would like assistance with any of the above requests or applications, Creative CFO is here to help, just click on the applicable product and we will get in touch.

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Whether you are a new startup trying to raise seed capital, determining how to allocate the company shareholding or looking to benefit your employees – equity incentives can be a game changer.

Equity sharing not only rewards employees but recognises the importance of them to their company. In turn, the company is able to attract, incentivise and retain performing and loyal employees.

The incentive industry, like the entrepreneurial industry around it, is constantly evolving. In addition to the traditional employee share incentive schemes which remain popular, we have seen the evolution of the SAFE (Simple Agreement for Future Equity) Agreement and Grunt Funds.

In order to implement any equity sharing models, it is of the utmost importance to understand the whys and hows behind each one.

Traditional share incentive schemes

Share incentive schemes are used by companies to grant their employees an option to obtain shares in the company, as an incentive to the employees.

The incentive is that the options may only be exercisable after a specific time period or are dependant on the future performance of the employee, thereby linking the growth of the company with that of the employees’.

The most common types of schemes are share option schemes and phantom share schemes:

  • Share option schemes

Employees are granted company shares which will vest at a later predetermined date. Shares can be offered to the employee at a market-related or discounted value. Companies can grant shares on a discretionary basis and can be linked to employee performance/longevity.

Share option schemes are most suited for companies wishing to provide employees with the opportunity to acquire actual ownership in the company.

  • Phantom or cash-settled share schemes

Employees are granted an opportunity to obtain a cash benefit derived out of a share, payable at a later predetermined date. However, the shares never vest and the employees do not become a shareholder. Companies can also grant such awards on a discretionary basis and can be linked to employee performance/longevity.

Phantom or cash-settled share schemes are most suitable for companies who don’t want to share ownership and may have a larger number of employees they wish to acknowledge and benefit.

Simple Agreement for Future Equity Agreement

SAFE agreementsare intended to provide a simpler, more cost-effective mechanism for start-ups to seek early-stage funding. The agreement was designed with simplicity in mind, taking into account both the investor and the company’s interests.

A type of ‘deferred equity contract’ – a SAFE agreement between an investor and a company provides the investor with rights to future equity in the company in exchange for funding. Thereby postponing the valuation of the company until a later date, allowing the investor to benefit in the upside of the growth of the company.

This is beneficial to the company in the sense that, SAFE shares are classified as equity rather than debt, having no fixed maturity date nor incurring interest. The investor will receive the future SAFE shares upon a triggering event, but until such event occurs they acquire no right to equity or to have their investment repaid.

Three such major triggering events include equity financing, acquisition or dissolution. Upon an equity financing event, the company will issue preference shares to the investor or should the company be acquired or dissolved before such financing event these happenings will constitute an event itself.

Grunt Funds

The objective of a grunt fund is to make sure that startup founders are rewarded for everything they offer their company, not just the money they actually invest. Grunt funds are dynamic meaning they recalculate equity stakes as contributions to the company changes.

The comparison of a company and a pie is used and a grunt fund determines how to slice the pie by allocating a monetary value to tangible and intangible contributions made to the company.

A grunt fund is based on fairness, basically, each shareholder is rewarded with a percentage of the pie based on the ratio of their contribution to the total contributions (of time, money, intellectual property, loans or unreimbursed expenses etc). The value of the contribution is determined with reference to the given formula/cash multiplier, specific to that type of contribution.

Upon real revenue generation or a cash investment, the company would then allocate the shareholders real equity in the company, allowing them to fairly share in the equity of the company.

Equity sharing can be a difficult conversation to have but by choosing the right equity sharing model for your company it will ensure that the company and investor/employees’ rewards are aligned.Equity incentives can also be very complex, with tax implications for both the company and employee. A well-designed scheme will ensure that the benefits are passed to the employees in the most tax efficient manner.

If you would like to find out more about one of the models above or require assistance with the implementation and managing the tax implications thereof please book a consultation session with a Creative CFO consultant.

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Background

Cryptocurrency is a virtual or digital currency that can be digitally traded as a medium of exchange. Virtual currencies were designed to be a type of currency which is solely controlled by its individual user with peer-to-peer technology to operate and removes the central or commercial banks from the process.

Although virtual currencies were originally designed as a type of currency, they are currently being treated as high-risk speculative investments due to their price volatility. Consequently, there is a substantial amount of hoarding and less real trade. Efforts are being made to change this by increasing merchant acceptance and promoting awareness of the advantages. Wide acceptance of virtual currencies could have a substitution effect on central or commercial bank money and roles.

South African regulatory landscape

The South African Reserve Bank (SARB) issued a Position Paper on Virtual Currencies in 2014. The SARB stated that only they are allowed to issue legal tender i.e. banknotes and coins, therefore virtual currencies are not considered a legal tender and should not be used as payment for the discharge of any obligation to settle a debt. There are many legal uncertainties regarding virtual currencies, such as the lack of a proper regulatory and legal framework. Particularly the enforcement of the principle of finality and irrevocability in the payment systems. For those trading in virtual currencies, there is the potential risk to incur financial losses, due to the price volatility as the demand and supply are controlled by individuals.

The main objective of the South African Exchange Control Regulations (Regulations) is to prevent the loss of foreign currency through the transfer abroad of real or financial capital assets held in SA, as well as constitute an effective system of control over the movement into and out of SA of financial and real assets.

The Regulations do not currently explicitly consider virtual currencies in the definition of “foreign currency” as defined. However, if virtual currencies were to fall under this definition the possibility exists that the Regulations will be applied to such transactions.

The anonymity of virtual currency transactions could result in exchange control circumvention as the transfer would not be affected and reported as required. Investors who acquire virtual currency in terms of their foreign capital allowance, do so at their own risk and have no recourse to SA authorities. The Regulations do not support the transfer of virtual currencies in and out of SA, therefore the SARB cannot authorise requests to trade in virtual currency cross-border. Any such trades and the risks associated thereof are for the individuals involved.

Currently individuals are entitled to a single discretionary allowance of R1 million per calendar year, however, exchange control regulations allow individuals to transfer R10 Million out of South Africa each year as part of their foreign investment allowance, subject to obtaining a SARS Tax Clearance Certificate (TCC). SARS require supporting documentation when applying for a TCC which include but are not limited to providing the relevant material that demonstrates the source of the capital to be invested.

South African tax treatment

To date, the South African Revenue Service (SARS) has not issued any guidance paper on the taxation treatment of virtual currency transactions. However, SARS participated together with the Financial Services Board and the Financial Intelligence Centre in the issue of a User Alert to the South African (SA) public in 2014. In essence, virtual currencies are unregulated and no legal protection or recourse will be afforded to users of virtual currencies.

Therefore the common misconception is that this means that no tax has to be paid on such gains, however, SARS have confirmed that transactions or speculation in virtual currencies are subject to the general principles of South African tax law and are taxed respectively.

The dictionary meaning of the term “asset” implies that the asset needs to bear value to the owner. When considering the meaning of the term “asset” as defined in the tax legislation, it appears to be wide enough to include virtual currencies as a form of property (asset). However, due to the fact that virtual currencies are not yet widely accepted in SA as a medium of exchange, virtual currencies are not likely to be classified as a “currency” in terms thereof.

Therefore, when exchanging virtual currencies for Rands, the same taxes apply as any other disposable assets which may result in a capital gain or could qualify as income.

What is of importance in determining whether it is capital or revenue in nature is the intention of the taxpayer when obtaining, keeping and at the time of disposing or exchanging the virtual currency.

If the taxpayer intends trading virtual currencies with the purpose of making a profit, such profit would meet the definition of gross income and would be taxed as income in your hands at the relevant individual tax rate. Such taxpayer will also have to account for trading stock in determining his taxable income. Consequently, any expense that you incur in the production of the income can be deducted. Taxpayers trading virtual currencies may have to include exchange differences of a revenue nature when determining their taxable income.

If a taxpayer buys and sells virtual currencies once off (not regularly) and your intention was to hold the asset for capital gain (long-term investment), the resultant gain or loss would be capital in nature and treated as such for income tax purposes.

Note

Please note that the information contained in this blog post should not be seen as advice in terms of the SARS regulations or Financial Advisors and Intermediary Services Act, but we trust that it provides some clarity on the tax position.

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