1.

Fundamentals of
Business Taxation
Good TAX (Adam Smith’s)
Fair (reflect person’s ability to pay)

Absolute (certain not arbitrary)

Convenient (easy to pay)

Efficient (low collection costs)

3 major principles of a good
TAX policy
Equity - a good tax should be fairly levied between one tax
payer and another

Efficiency - a good tax should be cheap and easy to collect

Economic effects - a good tax should consider the way in

which a tax should be collected
 Taxes imposed directly on the person or
Direct Taxes enterprise required to pay the tax (eg
income tax)

Imposed on one part of the economy

Indirect Taxes with intention that tax burden is passed
to another (eg VAT)
 Incidence

Incidence of a tax is the distribution of the tax burden, ie. who is

paying the tax

Formal Incidence - person who has direct contact with the tax
authorities, i.e. who is legally obliged to pay the tax

Actual Incidence - person who actually ends up bearing the

costs of tax
Taxable person - the person accountable for the tax payment

Competent jurisdiction - tax authority that has the legal power

to assess and collect the taxes. This is usually the combined
responsibility of the central government and local authorities.

Hypothecation - this means certain taxes are devoted to certain

type of expenditure (eg. Road tax).

Tax Gap - gap between theoretically collectible tax vs actually

collected.
 Tax Rate structure
Progressive taxes

Proportional taxes

Regressive taxes
 Sources of tax rules
Legislation produced by a national government of the country
eg. Financial Acts in UK

Precedents based on previous legislation - tax authorities issue

also issue interpretations

Directives from international bodies such as European Union

guidelines on VAT

Agreements between different countries, eg. Double taxation

treaties
 Calculation on the trading
profit
The accounting profit is the profit shown in financial statements before taxation

Income exempt from tax or taxed under other rules is any income included in the
accounting priofit which does not relate to the main trading activity, i.e. rental
income, interest receivable, etc, that maybe taxed under other rules or income exempt
from taxation under that particular countries rules

Disallowable expenses are expenses that have been deducted from the accounting
profit, i.e. they are allowable under the accounting standards, but for tax purposes
can’t be claimed

Depreciation is added back because it is an accounting entry that is not allowed for
tax purposes because is too subjective (i.e. you can choose the way to depreciate your
asset)

Tax depreciation may be called capital allowances in the exam. The rules will be
given in the exam to tell you what can be claimed. They are often given on a reducing
balance basis. Allowances are given if the asset is owned at the accounting date.
WDV - written down value

WDV means written down value. This represents the costs of

the asset less accumulated tax depreciation
 Balancing allowances
When an asset is sold any accounting profit or loss must be
disallowed for tax purposes and replaced by the tax equivalent
know as balancing allowance or charge

BA = loss on disposal (proceeds < TWDV)

BC = gain on disposal (proceeds > TWDV)

 Tax pro forma
Accounting profit X

Less: income exempt from tax or taxed under other rules (X)

Add: disallowable expenses X

Add: accounting depreciation X

Add: accounting loss on disposal of asset X

Less: accounting profit on disposal of an asset (X)

Less: tax depreciation (X)

Add: tax profit on disposal of an asset (BC) X

Less: tax loss on disposal of an asset (BA) (X)

Taxable profit X
 Trading losses

Possible ways of relieving a loss are:

Carry losses forward against future profits of the same trade

Carry losses backwards against previous periods

Offset losses against group company profit

Offset losses against capital gains in the same period

 Cessation of business

If an enterprise ceases to trade, most countries allow the entity

to Carry back the loss against profits of previous years go
generate tax refund. In the UK this is called Terminal Loss
Relief and can be carried back 3 years.