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Egyptian Income Tax

Part One
Income tax of Natural Persons

Edited by:
Pro.Said Abd El-Moniem
2014

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Lecture Nine
Chapter Five
Revenues of Commercial and
Industrial Activity

Edited by: Dr. Engy El Hawary


1-Nature of Revenue

This revenue results from the utilization of work and capital in the
pursuit of gain.

Tax is imposed on revenue resulted from any commercial or industrial


activities.

Taxable entities are sole-proprietorship and partnerships of in fact


companies created between heirs, each within his own share of the
profits.
2-Conditions for leving tax

1- The existence of the firm


The functional existence (not the physical existence) of an
organization for carrying on the activity will ensure the performance of
the work in a regular and continuous manner to gain.
2- Practice of the activity independently.
The taxpayer performs the activity for his own account and under his
own responsibility without third party participation.
If the owner delegates the authority of management to some one, the
money received by such person is not taxable as commercial and
industrial activity, but taxable as salaries.
Accordingly, tax is imposed on sole proprietorship and not partners in
general or limited partnerships except the case of inheritance.
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3- Practice of the activity in a usual manner.

But there is an exceptional case which is the net


profits of a single deal (transaction) of any commercial or
industrial activity.

4-Intention of realizing profits.

5-Realization of profit in Egypt regardless of the


nationality or home of the owner.

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3-Scope of Tax
1-Profits of Commercial or Industrial firms

The tax legislator did not define the commercial firms so we should refer to the
Egyptian code of commerce of 1999 that provided some examples of certain
commercial acts.

Industry is one of the commercial acts but the law distinguished between two
types of industry: A) Conversion industry (converts some materials to things in
another shape for another party in a regular manner or for selling them after
conversion for himself even once will be considered as commercial)

B)Extracting industries (extracting natural recourses as oil, gas for selling them
provided that this act is carried on regularly. 6

The profits of both are taxable whether carried on as a profession or once


2- Craftsmen and small activities:
Craftsmen are those who carry out certain trades depending basically on
their own skills and personal experience using some tools and their clients
may provide them with raw materials as tailor, carpenter, plumber
(according to law of 2005, not the commercial law 1999).

3- Profits of Single deal:


The single deal is defined by law as follows:
Eachpurchase of movable assets by resident taxpayer for selling not for
personal use provided that:
1- The intention is commercial or industrial.
2- The selling is within 12 months from the purchase date.

4-Profits of brokers, commission agents and other middlemen working as


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5- Profits of lease of shops and machineries:
Leasing a commercial or industrial shop with its machines and furniture
and trademarks (empty shop is not taxed)

Leasing machineries as mechanical, electrical , electronic except


agricultural tractors and machines.

6- Profits of transportation activity

7- Profits of building or buying realties in a customary way for selling


them. Such sale should be preceded by erection or buying.

8- Profits of dividing lands for building on them. If building takes place


without division is not taxable (taxed at 2.5% as alienations)
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9- Profits of land reclamation or plantations firms (the first
10 years only are exempted).

10- Profits of animal and fisheries projects (the first 10


years only are exempted)

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Prescribed Tax Exemptions

Prescribed Tax Exemptions

Qualitative exemptions Special exemptions

1- Returns of bonds and finance instruments issued by


government or listed corporations.
1- Land reclamation or plantation firms (first
10years) 2-Dividends of shares in joint stock companies.
3-Capital quotes in limited liability companies.
2-Poultry production firms (first 10 years)
4- Quotas of partners other than shareholders.
3-Bee- Nursing firms (first 10years)
5- Distributions of investment instruments issued by
4- Cattle stables and its fattening (first 10years) mutual funds.
5-Fisheries and farming projects (first 10years) 6- Returns of deposits and saving accounts ,
investment certificates with registered Egyptian
6- New projects financed from the social banks.
development fund (first 5 years on a condition
7-Returns of deposits and saving accounts with post
that the exemption not exceeding the 50% of offices.
the profit and not more than L.E 50,000 and the
taxpayer keeps regular books. 8- Returns of securities and deposit certificates issued
by the central bank.
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Accounting profit and Taxable profit

Accounting profit (loss) is net profit (loss), for a period before deducting income tax expense.

This profit is determined according to accounting principles and standards generally accepted in

the accounting profession.

But, taxable profit (loss) is the profit (loss) for a period, determined in accordance with rules

established by the tax law and rulings issued by the tax authority in each country, upon which

income taxes are payable (recoverable).

Thus, Accounting profit is usually different from that determined for tax purposes.

Differences between accounting profit and taxable profit are either permanent differences or

temporary differences.
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Permanent Differences

These differences arise because the income tax regulations treatment for certain transactions

differs from their accounting treatment. Permanent differences will not reversed in subsequent

periods, and accordingly, do not need for deferred tax recognition.

Examples of these permanent differences:

1- Revenue recognized for accounting purposes that is not taxable, such as returns of deposits

and savings accounts with banks.

2 -Expenses recognized for accounting purposes that are never deductible for income tax

purposes.

3 -Income tax deductions that do not qualify as expense for accounting purposes.
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Temporary Differences

1- Timing differences:

These differences arise when taxable revenues or gains, or tax deductible expenses or losses, are

recognized in one accounting period for accounting purposes, and in different period for income tax

purposes. The resulting tax consequences affect current and future accounting periods.

These timing differences result in assets and liabilities having different bases for accounting

purposes than for income tax purposes at the end of a given accounting period.

2-Depreciation or gain or loss recognition: Additional temporary differences occur because

specific provisions of the tax law create different bases for depreciation or for gain or loss recognition

for income tax purposes than are used for accounting purposes.
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The effect of such differences:
Accordingly, such differences cause current tax profit to be less than current accounting profit, which

in turn, cause future taxable profit to exceed future accounting profit. This difference is taxable in future

accounting periods, and is termed "a taxable amount".

The opposite occurs for originating differences that cause current taxable profit to exceed current

accounting profit. These temporary differences result in future "deductible amounts".

The existence of future taxable or deductible amounts implies that temporary differences have future tax

consequences.

The future tax consequences argument rests on the inherent generally accepted accounting principles (GAAP)

assumption that reported amounts of assets and liabilities will be recovered or settled, respectively.

For example, GAAP requires lower- of- cost- or market for assets when full recovery of cost is not expected.

This assumption implies that reversals of temporary difference occur when reported amounts of assets are
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recovered or reported amounts of liabilities are settled.


Examples of timing differences are:

1 Revenues or gains are included in accounting profit prior to the time they are included in taxable profit,

such as, compensations received from insurance company as a result of damages suffered by the firm

from un-implementation of contracts, are included in accounting profit on accrual basis as it is earned as it

is earned, but is generally reported for tax purposes on cash basis. (compensation received taxable when

it is received)

2 Expenses or losses are deducted to compute taxable profit prior to the time they are deducted to

compute accounting profit, such as, a fixed asset may be depreciated by accelerated depreciation for

income tax purposes and by the Straight line method for accounting purposes.

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3- Expenses or losses are deducted to compute accounting profit prior to the time they are

deducted to determine taxable profit, such as, product warranty costs are estimated and

recorded as expenses at the time of sale of the product for accounting purposes, but

deducted at actually incurred in later years to determine taxable profit.

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Determination of tax base:
The accounting net profit (loss) should be adjusted to be adjusted taxable net profit(loss) as follows:
Net profit (loss) according to the income statement L.E XX
Add:

1-Expenditure not allowed for tax purposes XX

2- Revenue not credited in the income statement but taxable under tax law XX

Total Taxable profit(loss) XX

Deduct:

1- Expenditure not charged in the income statement but allowable for tax purposes XX

2-Revenue included in the income statement but not taxable under tax law XX (XX)

Adjusted net profit XX

3-Contributions and subsidies paid to the Egyptian societies and institutions registered, educational institutions XX
and hospitals, and the Egyptian scientific research institutions
4-Losses carried forward XX (XX)

Tax base XX

5-Tax exemptions (XX)

Taxable net profit (tax base) XX


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Taxable revenues

Revenues of Subsidiary
Capital gains
current activity revenues

Revenues realized not from From


the basic activity compensations
From sale of
Commercial firms Industrial firms as compensations, for destruction or
fixed assets
collected bad debts, requisition of
subsidies, foreign currency fixed assets
variance, building and
agriculture land revenues,
treasury notes returns,
returns of deposit and
saving accounts, proceeds 18

of dealing in securities
Revenues of Commercial and Industrial firms:
The tax treatment of operating revenues.

Operating revenues are increases in O.E resulting from business main activities
(sale of merchandise or performance of service). In Commercial and Industrial firm

Gross profit = Net sales revenue cost of goods sold

The tax treatments of the factors of the above equation are explained under the
following titles:

A- Tax treatment of sales revenue:

Net sales revenue = gross sales- sales returns and allowance

Sales are the principal source of operating revenues. An understatement of sales in


a year causes understatement of taxable net profit in that year.
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You must consider the following points related to sales items:

1-The Revenue Recognition Principle, revenues should be recorded when service is


performed or when goods are sold to customers regardless of when cash is
received.

2- The withdrawals of goods by the owner for his personal use are recorded at the
cost of the goods which were withdrawn as this transaction does not derive real
profit.

3- The delivery of goods to local branches or selling agencies does not also derive
real profit because these profits are not realized until the goods sold. They should
be are recorded at the cost

4- When goods are exchanged for a fixed asset, it is deemed a sales transaction.
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The price of sales represents the fair value of the received fixed assets.
B- Tax treatment of cost of goods sold:
Cost of goods sold= beginning inventory + net purchases (or COGM) - ending
inventory
Where:
Net purchases= gross purchases purchases returns and allowance+ freight-in
expenses (any purchases costs).
COGM = Direct Material +Direct Labor+ Overhead +beginning WIP-ending WIP
Note: Purchases of goods for personal use is not included.
You must consider the following points related to costs items:
1- Ending inventory should include all goods owned by the taxpayer regardless of
the location. They include consigned goods (not sold by sales agents) and goods in
transit (held for sale by local branches and recorded as purchase).
2-Ending inventory should be recorded at cost.
Inventory valuation methods (FIFO, LIFO, WEIGHTED AVERAGE)are all accepted by
the Tax department but once one method is adopted it should be used in subsequent
Example 5-1

The net profit of sole-company for the year ended December 31, 2014 was L.E.
12,000. The tax examination revealed the following information:
1. There were sales invoices amount of L.E.1,500 which were not recorded at all in
sales account. The cost of these sales was L.E. 1,200.
2. Purchases include an amount of L.E 2,100 for a purchase invoice recorded twice
in the books
3. Goods in trust of agents were recorded, as sales, at 150% of their cost, though it
is proved at by year end that part of them costing L.E 1,500 still unsold by
agents.
4. The owner withdrew goods for his personal use. This transaction was not
recorded in the books. The cost of these goods is L.E.600 while its market value
is L.E. 750.
Required:
Make the necessary adjustments to measure the taxable net profit of the firm for
the taxable period 2014.
L.E. L.E.
Accounting net profit 12,000
Add: (any reductions made in taxable profit by recording any cost
decreases and revenue increases found)
1-Gross profit on goods sold, which are not recorded (1,500 -1,200) as 300
the unrecorded sales invoices reduces the taxable net profit by its gross
profit
2- Invoice recoded twice, because such double recording reduces the 2,100
taxable net profit by its value

3- Withdrawals of goods at cost as unrecorded goods reduces the taxable 600


net profit by its cost
3,000
Total taxable profit 15,000
Less: (any increases in taxable net profit by recording revenue decreases
and cost increases found )
Unrealized profit for the goods which are not sold by the sales agents as (750)
remaining goods in trust were valued at cost (1500X 50%)

14,250
Example 5-2
Net profit of industrial sole proprietorship from the income statement for the year 2014 was
L.E 50000. So, if you know that:

1- Transport expenses of purchases of raw materials include L.E 700 paid in advance.

2- Manufacturing salaries and wages not include L.E 2400 salaries for month of December.

3- The cost of raw materials inventory at the end of the year was L.E 5000 and its market value
was L.E 6200. The firm currently values inventory on the basis of cost, but the firm appraised
these raw materials at 10% below their cost.

4-The cost of raw materials in transit was L.E 9000. These raw materials were recorded as
purchases but not including in ending inventory.

5-Sales figure includes a sum of L.E 2000 the value of goods withdrew by the proprietor for his
personal use. These goods were purchased for L.E 1500.
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L.E L.E

Net profit according to income statement 50,000


Add to it :(any cost decreases or revenue increases found)
1-Advanced transport expenses are not allowed according to 700
the accrual basis.
2_ The valuation difference of the ending raw materials 500
inventory, as the value should be recorded at the cost 5000 x
10%
3- Raw materials in transit should be included in the inventory 9,000 10,200
as it is owned by the firm.
Total taxable profit 60,200
Deduct from it:( any cost increases or revenues decreases)
1- Accrued manufacturing salaries and wages according to the 2,400
accrual basis.
2- Unrealized profit for the goods withdrew by the proprietor 500 (2,900)
for his personal use as this goods should be recorded at the
cost. 2000 - 1500 = 25

Taxable net profit 57,300


Example 5-3
Industrial sole proprietorship has been using Full costing method with LIFO in the
preceding years, but it switched to variable costing with FIFO in the current year. So,
if you know the following:

1- The beginning inventory of finished production is 3,000 units at cost L.E 9,000.

2- Finished production during the year was 47,000 units.

3-Net sales during the year was 40,000 units.

4- The overhead cost was L.E 94,000 variable and L.E fixed.

Required:

Compute the difference resulting from changing the inventory valuation method for
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tax purposes.
1- Quantity of ending inventory:

Units
beginning inventory 3000
Finished production during the year 47,000
Total available 50,000
Less: Net sales (40,000)
Ending inventory 10,000

2- Determination of unit cost:


Items Full cost Variable cost
method Method
Variable cost 94,000 94,000
Fixed cost 47,000 ---
Total Costs 141,000 94,000
Quantity of finished units produced 47,000 units 47,000 units
Cost per unit 3 L.E / UNIT 2 L.E / UNIT

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3- The difference resulting from changing the inventory valuation
method:
According to the LIFO method with full costing method: L.E
Beginning inventory (3000 units*3) 9,000
From production (10,000 units ending-3000 beginning units) = 21,000
7000 units from production * L.E 3
Total 30,000
According to the FIFO method with Variable costing method:

From production 10,000*2 20,000

The difference 10,000

The difference should be added to the accounting profit and taxed


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