Taxation 1 / BAC 2674 / Tutorial 5 Business expenses Part 2

QUESTION 1

What is the principle in tax law as regards deduction of an expense against income?

ANSWER

The principle is contained in section 33 of the ITA. It spells out that

Subject to this Act the adjusted income of a person from a source for the basis period for a year of assessment shall be an amount ascertained by deducting from the gross income …all outgoings and expense wholly and exclusively incurred …in the production of gross income.

Essentially one need to consider the following:

1. The nature of the business deduction2. The nature of the expenses – whether revenue or capital3. Whether it is wholly and exclusively incurred4. Whether it is actually incurred 5. Whether it was incurred in the production of gross income.

One need to also check with section 39 that the said expenditure is not disallowed under that section.

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QUESTION 2

A company has a profit of RM 10,000 after incurring the following expenses:

Water bill 3,000

Traveling 10,000

Salary 30,000

Repairs and maintenance 20,000

Medical expenses for the staff 1,000

Loss on sale of fixed asset 3,000

Leave passage to the sales manager 5,000

Entertainment 25,000

Electricity 4,000

Donations to an approved institution 5,000

Depreciation 15,000

Bank interest 3,500

Audit fee 2,000

Advertisement 16,000

Administrative expenses 35,000

Accounting fee 1,000

Required:

1) What are the expenses that you would allow for income tax purposes to arrive at the adjusted income.

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QUESTION 3

Hullay Entertainment Sdn. Bhd. (‘the company’) trades in imported entertainment equipment which is popular among the teenagers. Its financial year end is 31 December. It had prepared its income statement for the year ended 31 December 2011 as follows:

Hullay Entertainment Sdn. Bhd.Statement of accounts

Year ended 31 December 2011Notes RM ‘000 RM ‘000

Sales 85,000Less: Cost of sales 1 64,000

21,000Less: Salaries and wages 5,600

Staff welfare 2 400Freight and insurance 3 700Traveling and entertainment 4 316Rental of premises 5 290Depreciation 240Bad and doubtful debts 6 750Tax and accounting fees 7 170Gain on disposal of fixed assets (2)Legal expenses 8 9Donations 9 3Profit before taxation 12,524

Notes to the accounts:

1 Cost of salesThirty units of the equipment from the opening stocks were transferred to fixed assets. The cost of the thirty units was RM 80,000 and the normal selling price is RM 96,000.

2 Staff welfareThis consists of the following:

Expenditure RM ‘000

Staff medical and dental expenses 80Leave passage for directors 30Education loan to employees written off 100Maintenance of child care centre 190

400

3 Freight and insuranceThis includes RM 99,000 premium paid to an insurance company incorporated in Malaysia for the good imported.

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4 Traveling and entertainmentThis includes an amount of RM 20,000 being annual dinner expenses for the staff, and lunches (wholly related to sales) for customers costing RM 35,000

5 Rental The rental of premises includes RM 60,000 paid for the months from November 2011 to January 2012.

6 Bad and doubtful debtsBad and doubtful debts are in respect of trade debts as follows:

RM ‘000General provision at year ended 31 Dec 2011 285Specific provision at year end 31 Dec 2011 415Bad debts on loan to employee 50

750

7 Tax and accountancy feesTax and accountancy fees include registration and secretarial fees of RM 20,000 on the increase of authorized share capital

8 Legal expensesThis consists of the following:

RM 000Legal fees on preparing loan agreement 4,000Fine imposed by the police for traffic offences 5,000

9,000

9 DonationsOn Christmas Day (25 December 2011) the company donated some mobile entertainment equipment being trading stock of the company to an approved orphanage. The equipments were worth RM 2,000. In addition, the company gave each of the orphans a cash gift of RM 20 totaling RM 1,000.

10 Capital allowancesThe company is entitled to an allowance of RM 204,000 for the year of assessment 2011.

Required:(a) Compute the tax payable by Hullay Entertainment Sdn. Bhd. for the year of assessment

2011 (b) Explain your treatment of each of the items mentioned in the note.

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Hullay Entertainment Sdn. Bhd.Year of assessment 2011

Notes RM ‘000

RM ‘000

(+) (-)

Profit before taxation 12,524Stock transfer to assets 96Medical and dental 0

Leave passage 30Education loan 100

Child care centre 0Insurance premium (double deduction) 99

Staff entertainment 0Rental of premises 20

Depreciation 240Bad and doubtful debts – general provision 285

Bad doubtful debts – specific provisions 0Bad debts – loan to employees 50

Registration and secretarial fess – share capital

20

Gain on disposal of fixed assets 2Legal expenses – bank loan preparation 4

Legal expenses – fine 5Donation in kind 2

Donations – cash to orphans 113,377 101

(101)Adjusted income 13,276

Less: Capital allowance 204 Statutory income from business source 13,072

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Notes:

Leave passage is specifically disallowed under the Income Tax Act 1967 (as amended)

Maintenance of child care is specifically allowed under the Income Tax Act 1967 (as amended)

Insurance premium qualifies for a double deduction as the insurance company is incorporated in Malaysia.

The cost of the entertainment expenditure is allowable since the main intention or purpose of the dinner is to entertain the staff. Entertainment of the customers is allowable as it is wholly related to sales arising from the business.

The rental paid for the period January 2012 does not relate to the current basis period and therefore is not deductible. But the expenditure would rank for a deduction in determining the chargeable income of the following year of assessment.

As for bad and doubtful debts, the general provisions are not deductible. The specific provisions would be allowable as it is related to the trade debts. As such no tax adjustments are necessary. Bad debts recovered in respect of the trade debts are taxable and as such no tax adjustments are necessary in this case.

Registration and secretarial fees in respect of the increase of share capital are capital expenditure and therefore should be disallowed.

The fine imposed by the police for breaking the law is not a trading expenditure. Donation in kind is not deductible in arriving at the total income. Also the cash given to the orphans directly do not amount to a donation to an approved institution itself – as such it is not deductible in arriving at the total income.

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QUESTION 4

SuperSaver Sdn. Bhd. was incorporated on 1.10.2006. The company commenced business on 1.2.2007 and make up its 1st set of accounts to 31.12.2007.

The company’s profit and loss account for the year ended 31.12.2007 is as follows:Note RM’000 RM’00

0

Sales 5,400Less: Cost of sales (1,540)

3,860Less:Payroll costs 1 1,160Freight and insurance 2 160Legal and professional fees 3 120Office up- keeping expense 4 40Miscellaneous expense 85Interest cost 5 70 (1,635)Net income 2,225

Notes:

1. Payroll costs : the above comprises ofRM’000

Salaries 720Bonus 80EPF 160Provision for retirement benefits 140Entertainment allowance 60

2. Freight and insuranceIncluded in the above expenditure is an amount of RM4,000 paid to Reliable Insurance Bhd. a company incorporated in Malaysia , for insuring goods imported by the company.

3. Legal and professional fees include:RM’000

Preparation of loan agreement 60Valuation of land 13Legal services on trade debt recovery 11Architect’s fees on building construction 10Stamp duty on increase in authorized share capital 20

4. Office up- keeping expense

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Included in the above expenditure are furniture and fittings costing RM10,000 purchased on 1.3.2007.5. Interest cost Included in interest cost is an amount of RM2,000 charged by a supplier for late payment of cost of raw materials .

6. Additional informationThe company is entitled to an allowance of RM 267,000 for the year of assessment 2007.

Required:

Starting with net income before taxation, compute the chargeable income for SuperSaver Sdn. Bhd. for YA2007 showing all the relevant tax adjustments.

Answer

Computation of chargeable income for SuperSaver Sdn. Bhd.

RM’000 ( -) RM’000 (+)

Net income 2,225

EPF nilProvision for retirement benefits 140Entertainment allowance 30Double deduction for insurance premium 4Preparation of loan agreement 60Valuation of land 13Legal services on trade debt recovery nilArchitect’s fees on renovation of premises 10Stamp duty on increase in authorized share capital 20Office up-keeping expense (furniture and fittings) 10Interest cost nil

Adjusted income 2,504Less: capital allowance (267)Statutory income / chargeable income 2,237

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QUESTION 5 – ADDITIONAL EXERCISE

Shuhaz Enterprise is a trading company. Its profit and loss accounts for the year ended 31 December 2011 is as follows:

Note RM RMSales 964,000Cost of sales (201,400)Gross profit 762,600Depreciation 3,450Legal charges i 3,140Promotional expense 2,750Entertainment ii 6,870Water and electricity iii 3,145Petrol cost for business vehicles 7,100General and administrative expenses 4,100Compensation vi 3,750Wages and salaries 76,560Motor vehicle expenses v 640Bad debts vi 5,400Tax consultancy charges vii 5,420Subscription to political party viii 1,400EPF contributions to employees 10,440 134,165Profit before taxation 628,435

Notes:(i) Legal charges of RM3,140 consists of :

RMLoan processing fee charged by the bank 1,200Cost of income tax appeal 1,940Total 3,140

(ii) Entertainment of RM6,870

This is the amount incurred for the Thanksgiving dinner treat held by Shuhaz at her home for the company’s customers to thank them for their overwhelming support of the business.

(iii) Water and electricity of RM3,145 consist of: RM

Water and electricity consumes 2,715Late payment penalty on electricity bill 430Total 3,145

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(iv) Compensation of RM3,750This refers to payment made to an employee injured on Shuhaz Enterprise’s business premise.

(v) Motor vehicle expenses of RM640 consists of: RM

Insurance on motor vehicle used in the business 500Fine for traffic offence 140Total 640

(vi) Bad debts of RM5,400In addition to RM600 in respect of an irrecoverable trade debt written off, this amount includes a loan of RM4,800 to a worker, which is now considered not recoverable. No provision has been provided for this debt.

(vi) Tax consultancy charges RM5,420In April 2011, Shuhaz sought advice regarding business tax matters from Outlook Tax Consultancy Sdn. Bhd. As a result, Shuhaz Enterprise was charged RM5,420 consultation fees.

(vii) Subscription to political party RM1,400Shuhaz is interested in politics. The amount of RM1,400 is the fee charged when Judy became a member of her favorite political party in the year of 2011 .

Other information:For the year of assessment 2011, capital allowances in respect of assets amounted to RM49,500.

Required:Compute the statutory income of Shuhaz’s Enterprise for the year of assessment 2011.

Note: Your computation should start with the ‘profit before taxation’ figure and follow the descriptions used in the notes to the profit and loss account. Indicate ‘nil’ in the appropriate column for any item that does not require adjustment.

(Total: 20 marks)

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Shuhaz’s Enterprise Tax Computation

RM ( - ) RM ( + )Net profit before tax 628,435Loan processing fee 1,200Cost of income tax appeal 1,940Entertainment (50% @ 6,870) 3,435Water & electricity NilLate payment penalty 430Compensation NilInsurance on motor vehicle NilFine by traffic police 140Bad debts NilLoan to workers 4,800Depreciation 3,450Promotional expense NilTax consultancy charges 5,420Petrol cost for vehicles NilSubscription to political party 1,400General administrative expenses NilWages and salaries NilEPF for employees (within 19%) NilAdjusted income 650,650Less: Capital allowance 49,500Statutory income 601,150

Note: EPF is allowed up to 19% of salaries and wages of employees. 19% of RM76,560 = 14,546. The RM10,440 paid to EPF is within the 19% allowable EPF. Hence, all EPF is an allowable expense.

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QUESTION 6 – ADDITIONAL EXERCISES

Batik Uniform Sdn. Bhd. is a business owned by Mr. Rashid. Currently, Batik Uniform Sdn. Bhd. produces and distributes quality uniforms including industrial uniforms, medical apparels and safety apparels to various customers. For the year ended 31 December 2011, the company’s financial statement is as follows:

Note RM’000 RM’000Sales 2,300Less: Cost of sales 1 ( 970)Gross profit 1,330Less: Operating expenditure

Marketing & Promotion Expenses 2 23Payroll costs 3 510Employees Provident Fund (EPF) 4 60 Professional fees and subscriptions 5 10Depreciation 6 60Utilities 7 180Provision for doubtful debts 8 30Other expenses 9 70Donations 10 15 (958)

372Add: Other income 11 40Net profit before taxation 412

Notes:1. Included under cost of sales are:

Damaged stocks written off RM27,000Provision for the foreign exchange loss expectedupon payment of raw material (textile) purchased RM32,000

2. Marketing and promotion expenses include:Donation of school uniforms to Bestari School RM 5,700Participation in an approved international trade fairs RM14,300Customers entertainment relating wholly to sales RM 3,000

3. Included under payroll costs are:Medical expenses of staff and their family RM 47,000Provision for retirement benefits RM 50,000Mr. Rashid’s salary RM 75,000Employees’ salary RM310,000Salary of two disabled47 operators RM 28,000

4. Included under EPF are contributions for:Mr. Rashid RM10,000Employees RM50,000

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5. Included under professional fees and subscriptions are:Audit and tax fees RM 9,800Annual subscription fee to ASEAN ManufacturersAssociation RM 200

6. Depreciation expenses comprise of depreciation for sewing machines, RM35,000 depreciation for office equipment, RM5,000, depreciation for furniture and fittings, RM5,000 and depreciation for vehicles, RM15,000.

7. Utilities expenses are expenses incurred for the purpose of business. It includes cost of electricity, water, telephone bills and rental of factory.

8. Provision for doubtful debts comprises:General provision for doubtful debts RM 8,000Specific provision for doubtful debts RM14,000Trade debts written off RM 8,000

9. Other expenses consist of:

Staff refreshments and annual dinner RM25,000Cost of new computerized security system RM45,000

10. Donations:A cash donation of RM15,000 was made to the Heart Foundation of Malaysia (an approved institution).

11. Other income comprises income derived from Malaysia as follows:Tax exempt dividend RM17,000Interest on deposits from bank licensed under the Banking and Financial Institution Act 1989 RM23,000

12. Capital allowance due for the year of assessment 2011 is RM80,000. This allowance has included all the qualified assets bought during the year.

Required:

Starting with the net profit before taxation, compute the total income of Batik Uniform Sdn. Bhd. for the year of assessment 2011. State your reason for the deductibility or non-deductibility for each of the item in your computation.

Note: You should indicate by the use of the word ‘nil’ any item referred to in the question for which no adjusting entry needs to be made in the tax computation.

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Suggested Template for solution:

Items Less (-) Add (+) ExplanationRM RM

Net profit before taxation 412,000 From Income Statement

(1) Cost of salesStock written-off Nil Realised loss-allowable Provision of foreign exchange loss 32,000 Non-allowable exp

(2) Marketing & promotionDonation of uniforms ? ?Participation in approved fairs ? ?Customer entertainment ? ?

(3) Payroll costsMedical expenses ? ?Prov. for retirement benefit ? ?Owner’s salary ? ?Employees’ salary ? ?Salary for handicapped staffs ? ?

(4) EPFMr Rashid ? ?Employees (50,000 – (19% x (310k + 28k) ? ?

(5) Professional fees & subscriptions Audit & tax fees ? ? ?Subscription fee to AMA ? ?

(6) Depreciation expense ? ?(7) Utilities ? ?(8) Provision for doubtful debtsGeneral provision ? ?Specific prov. for doubtful debts ? ? ?Trade debts written off ? ?

(9) Other expensesStaff refreshments ? ?Security systems ? ?

(10) DonationCash donation ? ?

(11) Other income

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Dividend ? After statutory income Interest ? After statutory income

? ??? ?Adjusted income ??? Less: Capital allowance (?) Statutory income from business ?

Add: Other incomeTax exempt dividend Nil Exempted Interest income Nil Exempted Aggregate income ?????

Less: Approved donations 15,000 Sec 44(6) Total income ???

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