Business Taxation BUSINESS INCOME - CA Sri Lanka...Business Taxation BUSINESS INCOME By Mahesh...

Business Taxation

BUSINESS INCOME

By

Mahesh Ranawaka Arachchi Deputy Commissioner -IRD

Introduction

“Business” has been defined to include:

• A trade, profession, vocation or isolated arrangement with a business

character however short the duration of the arrangement; and

• A past, present or prospective business.

Inland Revenue Act No. 24 of 2017

Mahesh Ranawaka Arachchi

Trade

Factors to be considered reference to trade

1. What is sold – Eg. Purchase of commercial quantities of product that cannot be used

personally.

2. Length of ownership – If asset is held for a short period of time, it suggests trade

rather than an investment.

3. Repetition – Repetition of transactions suggest a trade.

4. Supplementary work – Trade often process of works turn assets into saleable

products.

5. Motivation activity – Trade require assets or conclude contracts with the intention of

a making a profit.

6. Motivation for sale – Trades typically sell assets for the same reason they acquire,

them, in order to make a profit.



Changes in the Year of Assessment

Section 20 Accounting Period:-

For year of Assessment

Change in Accounting Period:-

With approval of the CGIR if think fit

If fails to comply with a term and condition attached to approval, may

revoke an approval



Method of Accounting – Section 21

• Inclusion and deduction shall be made according to general

accepted accounting principle.

• Individual shall account for income tax purpose on cash basis in

calculating individual’s income from an employment or

investment.

• Individual or entity conducting business shall account for income

tax basis an accrual basis.

• Other sources shall account either a cash or accrual basis

whichever properly computes the person’s income.



Method of Accounting

• With approval of the CGIR method of accounting can be changed if CGIR

shall be satisfied that the new method is necessary to properly compute

the person’s income.

• Where method of accounting changes, adjustment shall be made in the

year of assessment following the changes so that no item is omitted or

taken into account more than once.



Cash Basis Accounting – Section 22

Under the cash basis accounting-

a. Derives an amount when payment is received by or made available,

and

a. Incurs an expense or other amount when it is paid.



Accrual basis Accounting – Section 23

Under the accrued basis accounting:-

a. Derives an amount when it is receivable by the person,

and

a. Incurs an expense or other amount when it is payable.



Business Income

The following amounts shall be included in calculating the gains and profits of a person from conducting a business .

a. Service fees;

b. Consideration received in respect of trading stock;

c. Gains from the realization of capital assets and liabilities of the business as calculated

d. Amounts required to be included on the realization of the person’s depreciable assets of the business;



Business Income

e. Amounts derived as consideration for accepting a restriction on the

capacity to conduct the business;

f. Gifts received by the person in respect of the business;

g. Amounts derived that are effectively connected with the business

and that would otherwise be included in calculating the person's

income from an investment; and

h. Other amounts required to be included under this Act.



Business Income

The following amounts shall be included in calculating the gains and

profits of a person from conducting a business .

a. Service fees;

“Service fee” means a payment to the extent to which, based on

market values, it is reasonably attributable to services rendered by

a business of a person, but excludes interest, rent or a royalty.

Section 195



Business Income

b. Consideration received in respect of trading stock;

“Trading stock” means assets owned by a person that are sold or

intended to be sold in the ordinary course of a business of the person,

work in progress on such assets, inventories of materials to be incorporated

into such assets and consumable stores;

Section 195



Business Income

c. Gains from the realization of capital assets and liabilities of the business as calculated

“Capital asset”–

(a) means each of the following assets:

(i) land or buildings;

(ii) a membership interest in a company, partnership or trust;

(iii) a security or other financial asset;

(iv) an option, right or other interest in an asset referred to in the foregoing paragraphs; but

(b) excludes trading stock or a depreciable asset;

Section 195


13 Mahesh Ranawaka Arachchi

Business Income

d. Amounts required to be included by the 2nd or 4th Schedule on the realization of the person’s depreciable assets of the business;

“Depreciable asset” –

a. means an asset to the extent to which it is employed in the production of income from a business and which is likely to lose value because of wear and tear, or the passing of time; but

a. excludes goodwill, an interest in land, a membership interest in an entity and trading stock;



Business Income

e. Amounts derived as consideration for accepting a restriction on the capacity to conduct the business;

Example :

If some one received some amount for agreeing not to do a business.

e. Gifts received by the person in respect of the business;

when a gift is received, it is considered as part of the business income.

If the gift is in a kind – Cost equal to the amount include in the income



Business Income

e. Amounts derived that are effectively connected with the business and

that would otherwise be included in calculating the person's

income from an investment; and

f. Other amounts required to be included under this Act.



Business Income

The following amounts should be excluded when calculating a

person’s gains and profits from business.

Exempt amounts and final withholding payments;

and

Amounts that are included in calculating the person's

income from an employment.



Deductions

Deductions will be discussed relevant to the all source of

income, generally deduction of the Act falls in to three main

categories

• General deductions (Section 10)

• Main deduction (Section 11)

• Specific deductions (Section 12-19)



Calculation of Assessable Income from

Business

Income from business xxxx

Less : Exempt amounts xxx

: Final withholding payments xxx (xxx)

Liable Income from business xxxx

Less : Allowable deductions (xx)

Assessable Income from business xxxx



Business – Exam Purpose


+ -

Net Profit before tax xxxx

Less: Exempted amounts , Final Withholding payment, Amount that has included on Employment Income

xx xx xx

Add: Any Income that shall be considered only for tax xxx

Add: Disallowable Deductions

xxx

Less: Allowable Deductions xxx

Assessable Income from Business xxxx xxxx


Business – Adjustment required


Description For Accounts For Tax Adjustment Require ?

Inclusion (Income)

- Account prepared by adding the income and same consider for tax as well

Income Income No Adjustment

- Account prepared by adding the income but it should not add for tax

Income Not a Income Adjustment Required

- Account prepared without added income but it should add for tax

Not a Income Income Adjustment Required


Business – Adjustment required


Description For Accounts For Tax Adjustment Require ?

Deduction (Expenses)

- Account prepared by deducting the expenses and same allow for tax as well

Expenses Expenses No Adjustment

- Account prepared by deducting the expenses but it not allow for tax.

Expenses Not a Expenses Adjustment Required

Account prepared without deducting the expenses but I can be deducted for tax .

Not a Expenses Expenses Adjustment Required

General Deductions – Section 10

1. (a) No deduction shall be made in calculating a person’s income from employment [Sec.10(1)(a)]

(b) Certain specific deductions are not allowable in calculating a person’s income [Sec.10(1)(b)]

2. A deduction for a payment shall not be allowed until the tax, if required, withheld has been paid to the Commissioner General.



Example :

Requirement of deducting the WHT A company has paid rent to the owner of the building in respect of the premises used by the

company. Rent expenses charged to the income statement for the year ended 31.03.2019

amounting to Rs. 10,000,000. The company has failed to deduct required withholding tax at the

rate of 10% under section 84 of the Act.

Explain whether the company is entitled to deduct the rent expense in calculating business

income for the year of assessment 2018/2019.



General Deductions

3. No deduction shall be allowed except as expressly permitted

by the Act.

4. Where more than one deduction applies, the most specific

deduction shall be applied even if that results in the

denial(Rejection) of a deduction.



General Deductions - Section10

The following expenses shall not be deducted in

computing a person’s income *S.10(1)(b)] [specific

deductions ]

• Domestic expenses -Section.197.




Domestic expenses - Section 197

(1) Where an individual incurs expenditure in respect of himself, the

expenditure shall be domestic expenditure to the extent that it is

incurred-

• In maintaining the individual, including in providing shelter as well

as meals, refreshment, entertainment or other leisure activities;

• In the individual commuting (travelling) from home;

• In acquiring clothing, including shoes, for the individual, other than

clothing that is not suitable for wearing outside of work;



Domestic expenses • In paying any personal debts, including credit card debts, of the

individual.

• In educating the individual, other than education that is directly

relevant to a business conducted by the individual and that does not

lead to a degree or diploma; or



Domestic expenses (2) Where another person incurs expenditure in making a payment to or providing any other benefit for an individual the expenditure shall be domestic expenditure except to the the extent that-

• The payment or benefit shall be included in calculating the income of individual;

• The individual provides consideration of an equal market value for the payment or benefit;

• The amount of expenditure is so small as to make it unreasonable or administratively impracticable to account for it;



Domestic expenses (3)Expenditure referred to in subsection 1 and 2 include

interest incurred with respect to money borrowed that is used in

a manner referred to in those subsection.


General Deductions

• Tax payable under this Act or other taxes and levies specified

by the Commissioner General of Inland Revenue (CGIR).

• Interest, penalties and fines payable in relation to breach of any

written law.

• Expenditure in deriving exempt amounts or final WHT

payments



General Deductions

• Retirement contributions, unless those are included in calculating

the income of an employee or consist of a contribution by an

employer to approved funds by the CGIR (pension, provident or

savings funds or provident or savings society)

• Dividends of a Company

• An amount transferred to a reserve or provision for expenditure or

losses not yet incurred, but expected to be incurred in a future year

of assessment



General Deductions


• Outlays or expenses for entertainment

“entertainment” means the provision to any person of food, beverages,

tobacco, accommodation, amusement(Enjoyment), recreation or

hospitality of any kind”.

Section195

• Amounts incurred on lotteries, betting or gambling, other than

amounts incurred from conducting a business of lotteries, betting or

gambling


Main Deduction - Section11

• In calculating income from business or investment, the following

are deductible

(a) Expenses to the extent they are incurred during the year; and

(b) Incurred in the production of income.

• No deduction shall be allowed for an expense of capital nature.

“Expenses of a capital nature” includes an expenses that secures a

benefit capable of lasting longer than 12 months



Example : Main Deduction A company which is engaged in manufacture of commodity for local market, has incurred the following expenses.

Advertising and Sales promotion

Remuneration to employees

Arrears consultancy fee paid

Legal fees for recovery of trade debt

Prepayment made for insurance in February 2019

Surcharge for EPF arrears payment

Donation

Entertainment

Expenses attributable to dividend income

Management Fee

Decide whether the such expenses are deductible under the General & Main rule (Section 10 & 11).



Specific Deduction


• Interest Expenses- Section 12

• Allowance for trading stocks - Section 13

• Repairs and improvements – Section 14

• R & D expenses and agricultural start up expenses - Section 15

• Capital allowances and balancing allowances - Section 16

• Losses on realization of business assets and liabilities - Section 17

• Deductible amount of financial cost - Section 18

• Business or investment losses – Section 19


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