Corporate Tax 5 Objectives of the chapter: Tax planning and strategy General rule for admissible expense Flaws in some provisions Carry forward and setoff of losses Block assets and depreciation Double taxation Deferred tax Executive remuneration Provident fund contribution and trust fund Share option Transfer pricing Income from business or profession covers the corporate sector under sections 28, 29, and 30.Section 28 defines income, section 29 allowable deductions from income of business or profession, and section 30 deductions not admissible in certain circumstances (or maximum ceiling for certain expenses). Depreciation is allowed under the Third Schedule. Definition of income (ws 28) as defined below is faulty. This section separately explains income of life insurance companies and oil and gas industry (28(2). There are provisions deductions for expenses w/s 29 which (i) are incurred for the business, (ii) transaction based on market, (iii) and objectively estimated. Bad debts are allowed as admissible deductions but provision for doubtful debts is not allowed for the corporate sector except in banks. The sub sections xviiia and xviiiaa provide for provision for doubtful debts or classified loans which are faulty (explain in a separate chapter on banks).Advanced Issues in Taxatj . ‘lion There are exemptions from tax of newly established ere i flyover, gas pipe line. i export processing Zone, : ina ege and similar infrastructure) for ten years ae of exemption, beginning 100% of income in the first years and ending with 10% in the tenth year (u/s 46C). Physica, Hitech, at Teduced and secong There are provisions for unrecoverable tax of private companies (ug 100 in Chapter X. Liability in special cases). When a private company is wound up and any income 0 of any income year cannot be recovered, the every director shall be liable to pay the said tax Jointly and severally. General rule for Admissible Expense The expenses and losses which are considered for allowable deduction must fulfill the conditions (i) incurred for the business; if an expense or part of it is used by any member of the company is not an admissible expense; (ji) the transaction is market-based; if any transaction involves an expense higher than market because the transaction was done between related parties then the excess expenditure is not allowed as a deduction; (iii) objectively estimated, and (iv) the transaction is transparent and disclosed in the books of accounts. Inconsistencies There are certain inconsistencies in determining the admissible expense for entertainment, foreign travel, head office expense, and technical service fee (ws 30 f, g, h, j, k). These are tied to profit, that is, certain Percentage of profit except travelling expense which is tied to certain percentage of tunover. Tumover is better than profit for this Purpose. Turnover is usually consistent and stable over years but profit follows a zigzag road. Importantly, if a business makes a loss then according to the rules there are no allowable deductions for these iat but this does not make sense. Incentive bonus however is Tightly related to profit because bonus is pai pape us re iS amount of profit. is paid only when there isCorporate Tax 59 Tax Planning is Important Companies apply tax planning and strategies because they tax rates affect investment and financing decisions. Tax holiday, effluent treatment plant or tobacco industry, interest deductibility of debt capital, accelerated depreciation, employee remuneration and benefits are some areas where tax planning and strategy plays an important role. Here tax authority is an investment partner rather than a competitor. Shifting income from tax disfavored areas to tax favored areas legally is a lot of strategy, A business house always looks for maximum exemptions of income and admissible expenses. There are always the risks of frequent changes in the tax regime. Present value concept is very relevant in starting a long term project and employee remuneration, for example. Tax authority also applies various strategies for discouraging tax avoiding and evading behavior of taxpayers. Many countries including Bangladesh uses arms’ length price for restricting higher transfer price or imported price. Tax planning and strategy does not only consider tax issues but also nontax issues. For example, fringe benefits like insurance policy may be good for employees because it is tax free but employers may not think it better than giving cash for it has to arrange some extra administrative burden. Tax formula Revenue XXX Less exemptions (xxx), Gross income XXX, Less allowable deductions (xxx) Taxable income XXX Gross tax Xxx Tax credit/rebate (xxx) Tax payableAdvanced Issue 5. "Te, Kaj i) ion Some Faulty provisions Income (wis 28) . iness income as (a) profits and gains, ¢ The law bail Nene of the definitions are correct, Profs » a Dae used as income. Income Means, income " ee not make sense. Perquisites or benef Sin (C) are sey income of an individual not of a business. The simple definition of income from business is the difference of revenue and expenses Section 28 however, has a strength: it recognizes the fact that income measurement in a multi-period business like a life insurance busines, (2a) or an oil and gas industry (2b) is different from that ina Single period business in (1a and 1b). COM, nd pain Additional tax (16 B) If a listed company does not Pay cash or stock dividend, it shall pay an additional tax of 5% of income before tax. Even after this regulation companies rarely pay cash dividend once in three years on average. Stock dividend will not make much difference because it only increases capital of shareholders. But turnover (value of sales of Additional tax (16C) if 2 banking company cams Profit of more than 50% on capital meiading reserves then it shall pay an additional tax of 15% of profit tat, Th aw i faulty because (i) a company should not earn that much of profit, Gi) return on equity is not an appropriate measure of performance because banks do not Operate by equity capital but by ts (ii) even j ae Monopoly situation ma ae cam that much of profit it isCorporate Tax 6 Minimum tax (I6CCC) A company with gross receipts ore than TK500 million has to pay a minimum income tax of 0.3% of gross receipts even if it makes a loss. This provision violates the basic principle of taxation where income tax is paid on income. This provision was probably enacted because of the fact that companies have a tendency to show losses. However, one mistake cannot be corrected by another mistake and therefore the provision was discontinued in subsequent period. Premium on share issue (53L) Once there was TDS of 3% on premium on issue of shares and subsequently deleted. Premium is neither income from business nor a capital gain rather a part of capital. Therefore, tax on premium is not an appropriate provision. However, there is no grave fault on this provision because premium is a sort of capital gain as it represents reputation, goodwill, performance, and incremental profit earning capacity over the market or industry. Transfer Price (107 F) This section provides for a certificate by a chartered accountant of the authenticity of transfer price of goods imported. It gives monopoly to a particular class of accountants. There are other groups of accountants such as cost and management accountants (CMAs) and certified accountants (ACCAs). It is often claimed that chartered accountants had gone through practical experience and therefore the law rightfully recognizes that. But it should be noted that in most of the cases, CMAs and ACCAs qualify while they are on the job. Rarely any student qualifies without being on any job or practical experience. Carry Forward and Setoff of Losses Sections 37 to 42 of the Income Tax Act 1984 provide for carry forward and setoff of losses. These are provisions for allowing loss under any head in a year to carry forward to six subsequent yearsAdvanced Issues in Tay, n 62 . . hose years. But speculation loss and capitay 1.,- against income of # agpinst their respective incomes. Again loss from shall be set off alos cannot be set off against income from hoy, business or profes property. Example 7 ing income and losses during 2015. a eee TEs, income from house property Se pal value TK 90000), agricultural income TK 40099, hee aa TK50000, income from business TK50000 (sole pe eae loss on speculative business TK25000, capital os ty en the total income of the business while considering setoff and carry forward of losses u/s 37 to 42 of the Income Tax Ordinance 1984, Solution Total income, 2015-16: Interest on securities TKS000 Income from house property TK90000 Less repairs and maintenance @30% (27000) 63000 Agricultural income 40000 Less loss on tea 60% (agriculture) of TK50000 (30000) 10000 Income from business 50000 Less loss on tea 40% (business) (20000) 30000 Loss on speculative business to be carried forward and set off from speculative gain (25000) ae Capital loss to be carried forward and set off: ital gai Tot fen capital gain next year (30000) _ 108000porate Tax oe 6 Depreciation (Third Schedule) Depreciation is provided by the Third Schedule. There are rates from 2% to 100% of the written down value depending upon economic life, useful life, wear and tear, personal or business use, environmentally friendly or not, innovation or import, single or block asset, used first time or existing, using for life saving drugs, and employment generation. NBR allows reducing balance or written down value method (cost price less accumulated depreciation) for charging depreciation in general and straight line method (on cost) in special cases. Text books of accounting suggest the straight line method as the simplest method for calculating depreciation. It is not true for some assets like similar furniture and equipments. In straight line method, depreciation has to be calculated for each of these assets separately if these are purchased at different time and have different useful life. ‘This exercise takes time and need lots of information. However, some assets for newly established industrial undertaking are allowed accelerated depreciation and are based on Straight line method. Effluent treatment plants and other environment friendly equipments also get straight line method. (ws 7, 7A, Third Schedule). Ships which are less in number also allowed straight line method. Cost of all assets except motor vehicles as shown in the books of accounts, are accepted by NBR for determining WDV and depreciation allowance but each motor vehicle is allowed a maximum cost price of TK2 million (ws 6, Third Schedule). A business can buy a luxury vehicle but NBR cannot allow luxury for tax purpose. Block Assets Block assets are group of assets within a class of assets such as equipment and furniture. One rate of depreciation is applied on all furniture like chair and table. Similarly buses, lorries and taxies can be put together as a block item and a single depreciation applied. Written down value or book value of the block assets is taken for calculating64 Advanced lsues in Takai id just one amount of depreciation for the blogs ao income statement, Unlike straight line a of akes the calculation simple. In Income Tax oy, dinan Third Schedule, there allowed four Categories of blog, 1984, a buildings, office equipment, furniture ang fitin assets: buill een and ships. There are subdivisions for gir, gs, plant 7 sets and diferent rates of depreciation ate ugg, on — 10% depreciation for general buildings and 20% office and factory buildings, 20% for motor vehicles not for hire and 24y, for motor vehicles for hire. depreciation assets is charge’ WDV method mi Tent Unabsorbed Depreciation If the profits of a business are not sufficient to absorb the depreciation allowance, the allowance can be set off against the profits of any other business, or any other head. Any depreciation allowance still unabsorbed can be carried forward and set off against the profits of the business of the following year. Example XYZ Ltd has the following information in its income statement for the ending June 30, 2016. Sales revenue TK900 million, cost of goods sold TK600m, operating expenses TK150m, dividend income TK3m, income tax charged @25%, Scrutiny by NBR reveals the following (i) closing stock was overvalued TKO.8m, (ii) an old equipment was TK6m, cost price being TKSm and WDV TKTK3.8m, (iii) advance income tax Paid TK24m, (iv) operating expenses include depreciation ‘outa a TKa.Sm to each of its 15 directors, provision for pee ma NBR however allows depreciation of i lule, (V) TDS on dividend 10%. Determine (i) accountant’ j ee some and tax, (ii) NBR’s income and tax, (ii) toll ‘nd tax payable as per NBR.Corporate Tax 65 Solution (i)Accountant’s income Net profit before tax including net of capital gain as per books of accounts (TK900-600-150+(3/0.90)+(6-3.8)(1-0.15) TKI55.2 Less income tax @25% on income excluding capital gain (155.2-1.87) 38.33 Net income 116.87 (i NBR’s income Accountant’s income 155.2 Add excess depreciation TK0.6 Excess perquisites (0.5 x 15)-(0.45x 15) 0.75 Provision for doubtful debts 07 Less inventory overvalued (0.8) Capital gain (1.87) a «4.78 Net income before tax 150.42 Income tax @25% 37.60 (iii) Total income and tax payable Income from business 150.42 Less tax @25% 37.6 Net income after tax 112.82 Capital gain (sale — cost) = (6-5) 1 Capital gain tax @15% 0.15 0.85 Net capital gain 1.87 Total tax payable = income tax + capital gain tax -TDS — AIT = 37.6 + 0.85 — 0.33 -24=TK14.12 million Executive Remuneration Managers are usually risk averse but shareholders are risk takers. Also there is information asymmetry between managers and owners ina public limited company, that is, they have more information thanAdvanced Issues j f SSeS in Toy, Nation n 66 y not work for the share fore they may M0 Shareholders ~ and therefore Me? ts owners ane interests. Requirements: ee is cach situations, what remuneration scheme should the @ mn had ddopt that pursue managers to take risk and Work for col ers’ interest? shareholders’ inte _ comp: (ii) What are their tax effects for both company and the executives? Solution (i) The company can give the employees shares. These are long term incentive plans where the company’s shares are given as a part of remuneration. The benefits from shares come after a long time usually 3 to 4 years. The executives have the ownership now and therefore will take tisk and work for shareholders’ interests. (ii) The value of shares given is an admissible expense and the employer gets tax benefit at the tax rate applicable for the company. Employees pay tax at ordinary rates on the value of shares received and capital gain tax on the capital gain which is the difference between sale price and the value of shares on the date of receipt. Provident Fund and Gratuity Fund (First Schedule) Any contribution to employees for provident fund and gratuity is an allowable deduction from the company’s income. There are conditions eee the funds must be approved by NBR. These ae pe With employees’ contributions to provident fund matin ceil trustee board and the funds must be approved by NL Ee . fund is contributory, that is funded by both Gratuity fond on he on and is invested for profit and interest. ‘trust shall apply to NB] er hand is only the employer contribution. The R with the detailed rules of the funds. The rulesCorporate Tax 67 must include particulars of the trustee board, amount of employer and employee contribution, investment of the fund, qualifications for participating in the fund, and the provisions for receiving the benefits after retirement or any time before retirement. Example A public limited company has a contributory provident fund system which deducts 10% of employees’ basic pay and the employer contributes the equal sum. The basic pay of the employees is TK200 million. The First Schedule allows the employer’s contribution as admissible expense subject to conditions (i) there has to be a trust managing the fund, (ii) there has to be framed rules for the investment and distribution of the fund, and (iii) the requirements for employees to receive the benefits. Requirements: (i) what is the fund for the current year? (ii) What is the tax savings for the company? (iii) what will be the fund after 5 years at 11%? (iv) What is a trust and why it is important? Solution. (i)Fund for the current year = TK200 x 10% x 2=TK40 m (ii) Tax Savings for the company = TK200 x 10% x 0.25= TK5m. (iii) Fundy= Fundy (1 + 1)"= 40 (1.11) = TK67 million (iv) A trust is a group of persons independent of the company for managing the fund so that fund is not misused by the company and employees get maximum benefit. Is Corporate Tax Subject to Double Taxation? The answer is yes and no. In general yes because companies pay corporate tax and shareholders pay personal income tax when they receive dividend income. Small shareholders particularly individual shareholders do not suffer always because dividend income is exempt; Advanced lssues in Toca 6 Mion institutional shareholders however ha, gher income from dividend, But they do me he to tax on dividend when a company does eoeeel re dividend rahe retain the profit and reinvest, A company can also dis bute Droit “ tax deductible via interest, rent, royalty, remuneration, Again cain gains at the shareholder level are oe ee reduced rates in man countries and in Bangladesh only at 5% to 10% (u/s 53M and 54 oft, Income Tax Ordinance 1984). ‘rk 25000 a year: | Ve to because they have hi Corporate Tax Exemptions Need Reform Dhaka Stock Exchange and Chittagong Stock Exchange are exempted from income tax at 20% to 100% for a period of five years, Stock exchanges are same as other public limited companies and owned by industrialists. Garments industries used to pay income tax at 10% of their profit but 2014-15 Finance Ordinance provides tax at just 0.3% of export values at source and that is considered final settlement requiring no further tax on profit (u/s 53BB and 82C). These are some reasons why Bangladesh has one of the lowest tax-GDP ratio in the world. Question 1. Explain critically the definition of income from business ws 28 of IT ordinance 1984. In Bangladesh corporate tax rates were historically higher than individual Personal tax rates whereas in most other countries the opposite is true, that is, corporate tax rates were lower than aie Income tax rates, Explain the difference. Mi is the impact on taxable income if some expense 8 ca an admissible expense and not allowing it 9 , Ste, le expense but allowing it for tax rebate? bh al a madi 16 B of the Income Tax Ordinance 19% ; fein Profit of a listed company. ss 16 C of the Income Tax Ordinance 1984: Bx” Profit tax of g banking company,