May 05, 2008	Monday	Rabi-us-Sani 28, 1429

Successful enterprises are those which measure the quality of their business decisions with tax consequences. Any taxpayer ignorant about tax provisions may face grave risk.

It means that an investor, owner/manager or an entrepreneur/company must be aware of the opportunities and risks while transacting business and taking critical decisions about investment, development or employees’ welfare, because all this has a profound impact on the filing of annual tax returns.

The rule of the thumb is that sniffing instincts of a taxman can never be under-estimated. An entrepreneur will be well-advised to create wealth by observing the tax rules, as according to the new scheme, the ultimate responsibility about veracity of the tax returns rests upon a taxpayer, even when filed through a tax adviser.

For arriving at correct tax liability of business income, the tax law contemplates a two-staged scheme of computation (i) accounting computation of business income and, (ii) tax computation of the income. Errors in the accounting stage of computation are rectifiable, but amateurish, non-professional approach towards the second stage of tax computing is often fraught with grave risks. The greatest risk of business taxation is claiming legally inadmissible expenditures and ending up; (i) paying extra taxes penalties and, (ii) falling in the commissioner’s potential list for audit.

A businessman is averse to face a taxman in his audit venture. This article aims to inform taxpayers about their rights and obligations, the risk areas and an insight about the basic principles of business taxation to help them take tax- saving decisions.

Basically, a person’s income from business in a tax year shall be the excess or deficit of the total amounts (business revenues) over total admissible and business-related expenditures, i.e. whether revenue or capital in nature. Any expenditure revenue or capital that is an integral component of a business, professional or vocational cycle can be claimed as an expense. The excess of business revenue over admissible business expenses is recognised as profit and taxed progressively i.e. higher the income, higher the tax incidence. The business revenue is less than business-related expenditures, the loss is recognised and is adjustable against future income, if any, for six years.

Computation of taxable income of a business, profession or vocation is conditioned with two sets of business-related expenditures: (a) admissible and, (b) inadmissible.

Admissibility regime: Admissibility of business expenditures is not item-specific but principle-specific, i.e. any expenditure that satisfies the given three core principles is an admissible expense. These are, (i) the indispensability (wholly and exclusively expended for the purpose of business), (ii) the durability (has a normal useful life exceeding one year) and, (iii) the necessity.

A business income enjoys an unrestricted range of revenue expenditures and a restricted range of capital expenditures so far as they incur wholly and exclusively for the purposes of business, profession or vocation i.e. the principle of indispensability. A retail shopkeeper can claim expenses in the nature of rent, salesman’s salary, transportation charges etc. An advocate can claim expenditure for buying a new black coat or for dry cleaning charges of his necktie or shirts.

Likewise; a doctor can claim expenses for buying a stethoscope and for medicine inventory at his clinic. A plumber is allowed to claim expenses for tools and ancillary material for performing his job.

The tax law provides a restricted range of 10 types of admissible capital expenditures that satisfy the principle of durability. Of these four types of expenditure contemplate deduction of varying percentage of the cost of acquisition of all types of tangible and intangible assets employed in a business. These varying admissible sums are technically known as, (i) depreciation, (ii) initial allowance (additional depreciation), (iii) intangible (depreciation on intangible assets) and (iv) pre-commencement expenditure.

The rest of six types of expenditures contemplate admissibility of the whole cost that have durable impact to stimulate the socio-economic objects of public policy. These capital expenditures are technically known as, (i) scientific research expenditure, (ii) employee training and facilities, (iii) profit on debt, financial costs and lease payments, (iv) bad debts, (v) profit on non-performing debts of a banking company or development finance institution and (vi) transfer to participatory reserve.

These admissible capital expenditures must fulfil the principles of, (i) indispensability, (ii) durability and the prescribed criteria of (iii) eligibility. Two key components of eligibility criteria to claim any capital expenditure including tangible or intangible assets are, (a) ownership by a taxpayer and, (b) its usage for the purposes of business, vocation or profession.

Revenue expenditures incurred for restructuring of a corporate entity (merger, acquisition, amalgamation) as warranted by business prudence and involving legal, financial, advisory and administrative costs are admissible on the principle of necessity.

Inadmissibility regime: For safeguarding the integrity of the tax system the Income Tax Law contemplates a formidable range of 13 mandatory provisions, the violation of which may have bad consequences for the business as well as the taxpayers. When we appreciate the intent apparent and cumulative tone and tenor of these provisions, we find that all of them serve a common goal of punishing defiance to the desired behaviour of a taxpayer in term of repugnance to the express public policy objectives i.e. documentation of economy, non-compliance to withholding taxes obligations and violation of any law, rule or regulations in force, etc.

This formidable inadmissible regime of 13 provisions, in fact, torpedoes the following six types of derelict behaviour of taxpayers:

Abusive claim: A set of provisions in this regard repulses expenditure claims in the nature of; (a) any cess, rate or tax paid or payable by the person in Pakistan or a foreign country; (b)any amount of tax deducted at source on behalf of a person. Failure of tax deduction etc: This provision is the gravest landmine in tax laws as it ordains that where a taxpayer fails to deduct and deposit tax at the time of making payment on accounts of (a) salary (b) rent (c) brokerage or commission (d) interest (e) or payment to non-resident the whole of such amounts shall be disallowed and taxed.

Employer’s contributions: The law ordains that while setting up any welfare fund in the nature of (a) provident fund (b) pension fund and (c) superannuation fund, its prior approval from the commissioner of Income Tax is imperative. Otherwise any contribution made by an employer towards such welfare funds would be dismissed and taxed. In the same weightage, the law requires that while maintaining any approved welfare funds including the three funds; an organisation /firm/company must install strict internal controls to ensure that any excessive payment to an employee and falling in the nature of deemed salary income (perquisite) is duly subjected to instant tax deduction at source.

Expenses violative of law: The tax law ventures to regulate the behaviour of a taxpayer in ethical and social terms in the area of entertainment expenditure claim. It ordains that while incurring expenditure for, (a) entertaining foreign customers, suppliers/local customers or suppliers, shareholders, agents, directors or employees or at the time of opening of branches and, (b) serving refreshment to employees; only such expenditure shall be admissible as is consistent with the “norms and customs of business”. The tax law also punishes any behaviour that is repugnant to the rule of law. It ordains that any fine or penalty paid for violation of any law, rule or regulation for the time being enforced can not be claimed as a business expenses. It gives no premium to law breakers. Any taxpayer fined for theft of electricity can not claim such fine as an expenditure against his business income.

Expenses materially irrelevant: The letter of law repudiates the attempt to artificially inflate the business expenditures (evade taxes) as enumerated below:

(a) any personal expenditure incurred by the taxpayer; (b) any amount carried to a reserve fund or capitalized in any way; (c) any expenditure paid or payable of a capital nature; (d) any profit on debt, brokerage, commission, salary or other remuneration paid by an association of persons to a member of an association. The expenses shown in item (d), are declared inadmissible because according to the basic scheme of tax laws, legal identity of an Association of persons (AOP) and its member is indivisible.

Cash payments: Tax law is also used as a deterring instrument to strongly discourage the practice of cash payments in settlement of some critical transactions. Any expenditure for a transaction, paid or payable under a single account head (of account) which, in aggregate, exceeds Rs50,000 made other than by a crossed cheque drawn on a bank or by crossed bank draft or crossed pay order or any other crossed banking instrument showing transfer of amount from the business bank account of the taxpayer shall be disallowed and taxed. Any of the above transactions carried out on line or though credit card shall also be treated as documented transactions. Similarly, another provision discourages the payment of salaries in cash in excess of Rs10,000 per employee per month.

Micro, small and medium enterprises may have gravest tax consequences when failing to pay salaries exceeding Rs10,000 otherwise than by crossed cheque. Tax laws are equally pragmatic in respect of expenses which are documented by default and do not suffer from any monetary threshold for the purposes of their admissibility. These expenses are, (i) utility bills; (ii) freight charges; (iii) travel fare; (iv) postage and (v) payment of taxes, duties, fee, fines or any other statutory obligation.