BUSINESS INCOME Business Taxation - By Mahesh Ranawaka Arachchi - CA Sri Lanka
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Business Taxation
BUSINESS INCOME
By
Mahesh Ranawaka Arachchi
Deputy Commissioner -IRDInland Revenue Act No. 24 of 2017
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
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Interest Expenses – Section 12
The interest incurred by a person during the year under debt
obligation of the person shell be deemed to be incurred in the
production of income to the extend that-
a) The borrowed money was used to acquire an asset that is used
during the year in the production of income; or
b) The debt obligation was incurred in the production of income
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Allowance for Trading Stock – Section 13
“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
Section195
• The definition of ‚capital asset" and ‚depreciable asset" excludes
Trading stock. However it depends on facts of the case.
• Calculation of trading stock as sub section 2 of section 13
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Allowance for Trading Stock
The allowance shall be calculated as –
Opening value of trading stock of the business for the Y/A = ******
Plus: Expenses incurred during the on trading stock of the business = ****
******
Less: Closing value of trading stock of the business for the year. = ( ***)
Allowance for trading stock = ******
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Allowance for Trading Stock
Closing valve of trading stock shall be lower of –
a. The cost of the trading stock at the end of the year
b. The market value of the trading stock at the end of the year
According to this comparison, cost of the trading stock shall be
reset
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Example : Allowance for Trading Stock
Book profit of company has Rs. 60,950,000 for the year ended 31.03.2019.
Value of stocks as at 31.03.2018 and 31.03.2019 were Rs. 70,200,000 and Rs.
102,500,000 respectively. Its cost of purchase of stocks during the year of
assessment 2018/2019 was Rs. 255,200,000. The company has charged a sum of Rs.
240,100,000 as cost of sales in the income statement for the year ended 31.03.2019.
Make relevant adjustments to the tax computation based on the above
information for the year of assessment 2018/2019.
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Research and Development Expenses and
Agricultural Start up Expenses – Section 15
Research and Development expenses and Agricultural start up
expenses meeting the requirements of subsection (1) of section 11
may be deducted irrespective of whether they are of a capital nature
or not.
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Definition
‚Agricultural start up expenses” means expenses incurred by the
person in –
(a) opening up any land for cultivation or for animal husbandry;
(b) cultivating land referred to in paragraph (a) with plants;
(c) the purchase of livestock or poultry to be reared on land
referred to in paragraph (a); or
(d) maintaining tanks or ponds or the clearing or preparation of any
inland waters for the rearing of fish and the purchase of fish to be
reared in such tank, pond or inland waters, as the case may be;
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Definition
‚Agricultural start up expenses” means expenses incurred by the
person in –
(a) Carrying on any scientific, industrial, agricultural or any other
research for the upgrading of the person’s business through
any institution in Sri Lanka (or for any innovation or research
relating to high value agricultural products, by the person or
through any research institution in Sri Lanka); or
(b) The process of developing the person’s business and improving
business products or process,
which shall be beneficial to Sri Lanka, but shall exclude
expenses incurred that are otherwise included in the cost of
an asset under this Act.
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Capital Allowance and Balancing
Allowance - Section 16
A person is entitled to claim capital allowances
if such person is the owner of the depreciable asset; and
uses them at the end of a year of assessment in the
production of the person’s income from a business;
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Capital Allowance
Owned and Used - Temporary disuse
Example:
One of the printing machines of Company “A” is broken down and the Company has had
substantial problem of getting it repaired because they had to order parts from the European
manufacturer.
Hence the Company “A” had to wait 14 months. Despite the 14 months during which the
printing machine was not in use, Company A was actively pursuing its repair and did succeed
in having the machine put back into operation.
Company “A” may continue to claim capital allowances during the time it took to have the
printing machine repaired.
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Capital Allowance
Owned and Used
Example:
Company A runs a hotel. It commissioned Company Z to construct a new hotel in Colombo.
The contract price is Rs. 20,000,000 and the construction period is two and a half years.
Company A is required to pay the contract price in instalments as follows,
- deposit - 10%,
- after the foundations are laid - 20%
- after lock-up - 40% -
- on completion - 30%.
Is it eligible to claimed the Capital allowances
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Capital Allowance
• Shall be calculated
- According to the straight line method
- According to the second, fourth or sixth schedules
• Full capital allowances will be granted for the year of acquisition
• Capital allowance will not be granted for the year of disposal
• Shall not be deferred to a later year of assessment
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Capital Allowance
No Capital Allowance Shall be granted in respect of a road vehicle other than
- a commercial vehicle,
- a bus or minibus,
- a goods vehicle;
- or a heavy general purpose or specialised truck or trailer;
Definition of “Commercial Vehicle” mean,
- a road vehicle designed to carry loads of more than half a ton or more than 13
passengers; or
- a vehicle used in a transportation or vehicle rental business.
Mahesh Ranawaka ArachchiClas Depreciable Assets Number of Years
s
1 computers and data handling equipment together with peripheral 5
devices
2 buses and minibuses, goods vehicles; construction and 5
earthmoving equipment, heavy general purpose or specialised
trucks, trailers and trailer-mounted containers; plant and
machinery used in manufacturing
3 railroad cars, locomotives, and equipment; vessels, barges, tugs, 5
and similar water transportation equipment; aircraft; specialised
public utility plant, equipment, and machinery; office furniture,
fixtures, and equipment; any depreciable asset not included in
another class
4 buildings, structures and similar works of a permanent nature 20
5 intangible assets, excluding goodwill The actual useful life of the
intangible asset, or where
the intangible asset has an
indefinite useful life, 20.Inland Revenue Act No. 24 of 2017
Calculation of Capital Allowance
Formula for calculating capital allowance
A/B
A- The depreciation basis of asset at the end of
the year of assessment
B- Number of years (provided in the fourth schedule)
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Allowance Depreciation basis of
Depreciable Asset
• The depreciation basis of the asset at the end of the previous year of
assessment and (could be the cost or WDV)
• Amounts added to the depreciation basis of the asset during the year of
assessment including the excess expense of repair and improvements
referred to in section 14 for which a deduction shall not be allowed as a
result of the limitation.
Mahesh Ranawaka ArachchiRepairs and Improvements – Section 14
Expenses for the repair or improvement of depreciable assets shall
be deducted irrespective of whether they are of a capital nature or
not
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Definition
“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;
Section 195
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Limitation for Deduction
Assets categorized under
Buildings, structures and similar depreciable assets (Class 4)
- 5%
for all other cases - 20%
of the WDV of the asset at the end of previous year.
Excess expense for which a deduction is not allowed shall be added
to the depreciation basis of the asset.
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Example :Repair & Improvements and
Capital Allowances
Company runs a manufacturing business.
During the following years of assessments it incurs expenditure as follows:
- 2018/2019 : bought machine B for Rs. 2,000,000
- 2019/2020 : repairs and improvements to machine B Rs. 400,000
- 2020/2021 : repairs and improvements to machine B Rs. 200,000
Since the machine B is under class 3 , the deduction for repairs and
improvements is limited to 20% of the depreciation basis of the machine B at
the end of the previous Y/A
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
2018/2019 2019/2020 2020/2021
WDV of Machine B at the 1,600,000 1,200,000 + 80,000
beginning of the Y/A
(Depreciation basis)
Repair Exp. 400,000 200,000
Allowable 1,600,000*20% = 1,200,000*20%=
320,000 240,000
Allowed 320,000 200,000
Not allowed 80,000 Nil
Capital allowance 2,000,000/5 = 1,600,000/4= 1,280,000/3=
400,000 400,000 426,666
WDV of Machine B at the end of 1,600,000 1,200,000 853,334
the Y/A (Depreciation basis)
23An Assessable Charged is included
or Balancing Allowance is granted
Where a depreciable asset of a person is realised, when calculating
the person’s income;
(a) an assessable charge is included (profit) or
(b) a balancing allowance is granted (loss)
Mahesh Ranawaka ArachchiAn Assessable Charged is included
Example:
Company A runs a property rental business and owns a building of apartments
for rental. At the start of year 1, the balance in Company A's class 4 is Rs.
30,000,000, i.e. the balance at the end of the previous year less the depreciation
allowance granted for that year.
Company A is expecting to sell off a large number of the apartments in the
building except for a few select apartments. As a result, during year 1 it receives
Rs. 50,000,000 as proceeds from the sales.
Calculate the assessable charged or Balancing allowance for Y/A 2018/19
Mahesh Ranawaka ArachchiBalancing Allowances (Loss)
Balancing allowances are –
made in respect of depreciable assets
(a) (i) realised during a year of assessment; and
(ii) in respect of which capital allowances have
been granted in that year or an earlier year; and
(b) Calculated in accordance with the provisions of the second,
fourth schedule to this act.
Mahesh Ranawaka ArachchiAn Assessable Charged is included or
Balancing Allowance is granted
Example:
Company “R “sells office furniture at the price of Rs. 700,000 and at the time of disposal
the written down value of the asset is Rs. 1,000,000.
With respect to the office furniture, Company “R” will be granted a deduction in the
amount by which the written down value of the asset exceeds the proceeds of sale, i.e.
Rs. 300,000.
Sale proceed = Rs. 700,000
WDV = Rs. 1,000,000
Balancing allowance (Loss) = Rs. 300,000
Rs. 300,000 is allowed as a deduction when calculating company R’s business income
Mahesh Ranawaka ArachchiCapital Allowance for Leasing Assets
Where an asset is leased under the finance lease, the lessor shall be
treated as transferring ownership of the asset to the lessee.
Accordingly, the lessee is entitled to deduct capital allowance in
relation to the assets obtained under finance leasing.
Substance Vs. From
- No. 10 of 2016 -From
- No. 24 of 2017 - Substance
Mahesh Ranawaka ArachchiAn Assessable Charged is included or
Balancing Allowance is granted
Example:
Company “R “sells office furniture at the price of Rs. 700,000 and at the time of disposal the
written down value of the asset is Rs. 1,000,000.
With respect to the office furniture, Company “R” will be granted a deduction in the amount
by which the written down value of the asset exceeds the proceeds of sale, i.e. Rs. 300,000.
Sale proceed = Rs. 700,000
WDV = Rs. 1,000,000
Balancing allowance (Loss) = Rs. 300,000
Rs. 300,000 is allowed as a deduction when calculating company R’s business income
Mahesh Ranawaka ArachchiInvestment incentive as Second
Schedule
A person who invests in Sri Lanka (other than the expansion of
an existing business) during a year of assessment shall be
granted enhanced capital allowances, in addition to the capital
allowances computed under the Fourth Schedule.
Mahesh Ranawaka ArachchiEnhanced Capital Allowance as 2ND schedule
Condition Limitation Capital
allowance %
1. Used in a part of Sri Lanka On depreciable assets other than 100%
other than the Northern intangible assets -
Province USD 3 million -USD 100 million
2. Used in a part of Sri Lanka On depreciable assets other than 150%
other than the Northern intangible assets - exceeds USD 100
Province million
3. Used in the Northern On depreciable assets other than 200%
Province intangible assets - exceeds USD 3
million
4. State-owned company that are On assets or shares - exceeds USD 250 150%
used in a part of Sri Lanka millionCondition for claiming the
Enhanced Capital Allowance
Capital allowances arising above paragraphs of above table with
respect to a particular year of assessment cannot be accumulated
with another paragraph and shall be taken in that year and shall be
deferred to a later year of assessment.
Mahesh Ranawaka ArachchiTemporary Concession as Sixth
Schedule
A person who invests in Sri Lanka (other than expansion of existing
business) on depreciable assets mentioned in the following table
during a year of assessment shall be granted enhanced capital
allowances computed in accordance with this paragraph, in
addition to the capital allowances computed under the Forth
Schedule.
Mahesh Ranawaka ArachchiEnhanced Capital Allowance as 6TH Schedule
Condition Limitation Capital
Depreciable assets allowance
%
1. in a part of Sri Lanka 100%
other than the Northern Class 1 and class 4 assets
Province and plant or machinery
that are used to improve
business processes or up to USD
productivity and fixed to 03 million
2. in the Northern Province the business premises. 200%Temporary Concession as Sixth
schedule - Conditions
• Claiming of capital allowances cannot be deferred to a
later year of assessment.
• Deduction of capital allowances under this Schedule shall
expire three years after it becomes effective.
Mahesh Ranawaka ArachchiLosses on Realization of Business
Assets and Liabilities – Section 17
In calculating the person’s income from business, loss from the realization of asset and
liabilities shall be deducted.
Assets
Capital assets of a business used in the production of income from business.
Liability
Debt obligation incurred in borrowing money – money used or asset purchased
Other liability - the liability was incurred in the production of income from the
business.
Mahesh Ranawaka ArachchiDefinition
“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
Mahesh Ranawaka ArachchiDeductible amount of Financial
Cost – Section 18
The amount of financial costs deducted in calculating an entity’s
income for a year of assessment shall not exceed the amount of
financial costs attributable to financial instruments within the limit.
This rule does not apply to Financial Institutions from conducting a
business or investment and individuals (entity excludes individual).
Mahesh Ranawaka ArachchiDefinition
“Financial instrument” means
(a) (i) a debt claim or debt obligation;
(ii) a derivative instrument;
(iii) a foreign currency instrument; and
(iv) any other instrument prescribed by regulations or, in the absence of
regulations, treated as a financial instrument by generally accepted accounting
principles; but
(b) except to the extent as may be prescribed by regulations, excludes a membership
interest in an entity.
Section 198
Mahesh Ranawaka ArachchiLimitation for Financial cost
Formula:
AxB
Where:
‘A’ - total of the issued share capital and reserves of the
entity
‘B’ - (a) in the case of a manufacturing entity, the number 3;
(b) in the case of an entity other than a manufacturing
entity, the number 4.
Mahesh Ranawaka ArachchiLimitation for Financial Cost
For Manufacturing Entities
Allowable Finance Cost attributable to financial instruments =
Cost of Financial Instruments X [(Issued Share Capital and reserves) X 3]
Total amount of Financial Instruments
For Other Entities
Allowable Finance Cost attributable to financial instruments =
Cost of Financial Instruments X [(Issued Share Capital and reserves) X 4]
Total amount of Financial Instruments
Mahesh Ranawaka ArachchiLimitation for Financial cost
Example:
Company B is a garment factory and incurs interest expense (for what)
amounting to Rs. 4,500,000 during the year of assessment 2018/2019.
Balance Sheet of the company as at 31.03.2019 revealed as follows.
Stated Capital Rs. 6,000,000
Revenue Reserves Rs. 4,000,000
Long Term Loans Rs.40,000,000
Calculate the allowable interest expense according to thin capitalization
rule.
Mahesh Ranawaka ArachchiBusiness or Investment Losses
– Section 19
In calculating the income of a person from a business following
shall be deducted:–
(a) an unrelieved loss of the person for the year from any other
business; and
(b) an unrelieved loss of the person for any of the previous six
years of assessment from the business or any other
business.
Mahesh Ranawaka ArachchiBusiness or Investment Losses
Conditions
The person may choose the income calculation or calculations in which an
unrelieved loss or part of the loss is deducted.
Notwithstanding the provisions of subsections (1) and (2), where a person
makes a loss and if the loss were a profit it would be taxed at a reduced rate,
the loss shall be deducted only in calculating income taxed at the same reduced
rate,
If the loss were a profit and the profit would be exempt, the loss shall be
deducted only in calculating exempt amounts.
Mahesh Ranawaka ArachchiBusiness or Investment Losses – Section 19
Deduction Criteria
Income Source Eligible Loss Loss Income
Business income Unrelieved business
Loss of Reduced rate Same reduced rate,
• any other business Lower reduced rate,
• previous six years Exempt
Investment Income Unrelieved business
Loss Exempt Exempt
Investment LossDefinition
“Loss” means
of a person for a year of assessment from a business or investment shall be
calculated as the excess of amounts deducted in accordance with this Act
(other than under this section or subsection (5) of section 25) in calculating
the person’s income from the business or investment over amounts included
in calculating that income; and
“Unrelieved loss” means
the amount of a loss that has not been deducted in calculating a person’s
income under this section or subsection (5) of section 25.
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Business or Investment Losses
Example: How to sett the Investment and Business Losses
Business - 40% Business - 28% Business - 14% Exempted Investment
Income Income
Profit 1,000,000 5,000,000 (1,000,000) 2,000,000 2,000,000
Loss
B/F (2,000,000) (2,000,000) (1,000,000) (4,000,000) (3,000,000)
During Y/A 0 0 (1,000,000) 0 0
Total (2,000,000) (2,000,000) (2,000,000) (4,000,000) (3,000,000)
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Business or Investment Losses
Example: Solution -01 for how to sett the Investment and Business Losses
Business - Business - Business - Exempted Income Investment
40% 28% 14% Income
Profit 1,000,000 5,000,000 (1,000,000) 2,000,000 2,000,000
Loss
B/F (2,000,000) (2,000,000) (1,000,000) (4,000,000) (3,000,000)
During Y/A 0 0 (1,000,000) 0 0
Total (2,000,000) (2,000,000) (2,000,000) (4,000,000) (3,000,000)
Up front Loss deduction 1,000,000 2,000,000 0 2,000,000 2,000,000
Remaining Loss 1,000,000 0 2,000,000 2,000,000 1,000,000
Adjustment 0 0 0 0 0
Total Loss deducted 1,000,000 2,000,000 0 2,000,000 2,000,000
C/F losses 1,000,000 0 2,000,000 2,000,000 1,000,000
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Business or Investment Losses
Example: Solution -02 for how to sett the Investment and Business Losses
Business - Business - Business - Exempted Income Investment
40% 28% 14% Income
Profit 1,000,000 5,000,000 (1,000,000) 2,000,000 2,000,000
Loss
B/F (2,000,000) (2,000,000) (1,000,000) (4,000,000) (3,000,000)
During Y/A 0 0 (1,000,000) 0 0
Total (2,000,000) (2,000,000) (2,000,000) (4,000,000) (3,000,000)
Up front Loss deduction 1,000,000 2,000,000 0 2,000,000 2,000,000
Remaining Loss 1,000,000 0 2,000,000 2,000,000 1,000,000
Adjustment (1,000,000) 1,000,000 0 0 0
Total Loss deducted 1,000,000 3,000,000 0 2,000,000 2,000,000
C/F losses 0 0 2,000,000 2,000,000 1,000,000
Mahesh Ranawaka ArachchiInland Revenue Act No. 24 of 2017
Business or Investment Losses
Example: Solution -03 for how to sett the Investment and Business Losses
Business - Business - Business - Exempted Income Investment
40% 28% 14% Income
Profit 1,000,000 5,000,000 (1,000,000) 2,000,000 4,000,000
Loss
B/F (2,000,000) (2,000,000) (1,000,000) (4,000,000) (3,000,000)
During Y/A 0 0 (1,000,000) 0 0
Total (2,000,000) (2,000,000) (2,000,000) (4,000,000) (3,000,000)
Up front Loss deduction 1,000,000 2,000,000 0 2,000,000 3,000,000
Remaining Loss 1,000,000 0 2,000,000 2,000,000 0
Adjustment (1,000,000) 1,000,000 (1,000,000) 0 1,000,000
Total Loss deducted 1,000,000 3,000,000 0 2,000,000 4,000,000
C/F losses 0 0 1,000,000 2,000,000 0
Mahesh Ranawaka ArachchiApplicability of Specific Deductions
Section Expense Business Investment
12 Interest √ √
13 Trading stocks √ -
14 Repairs and improvements √ -
15 R & D and agricultural start up √ -
16 Capital allowances √ -
17 Losses on realisation of business assets and √ -
liabilities
18 Deductible amount of financial cost √ √
19 Business or investment losses √ √Reversal of amount including bad debts Reversal Where a person deducts an expense in calculating the person’s income and the person later recovers the expense, the person shall, at the time of recovery, include the amount recovered in calculating the person’s income. Disclaimer or Write off The person may, at the time of disclaimer or write off, deduct the amount disclaimed or written off in calculating the person’s income. a person can disclaim the entitlement to receive an amount or write off a debt claim as bad if the person has taken reasonable steps in pursuing payment and the person reasonably believes that the entitlement or debt claim will not be satisfied. Mahesh Ranawaka Arachchi
Limitation for Financial cost
Example:
Company which has a book profit of Rs. 20,100,000 for the year ended 31.03.2019,
has made following transactions.
- Made the provision for doubtful debts account for the year ended
31.03.2019 Rs.2,200,000.
Out of which a sum of Rs. 800,000 represents specific provision and
the balance of Rs. 1,000,000 is general provision.
- It has written off a total sum of Rs. 800,000 out of the general provision
made
To Trade debts of Rs. 500,000
To Staff loans of Rs. 300,000
Make the relevant tax adjustments for the year of assessment 2018/2019.
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