Advanced Taxation BUSINESS INCOME AND CORPORATE TAXATION By

Advanced Taxation BUSINESS INCOME AND CORPORATE TAXATION By Mahesh Ranawaka Arachchi Deputy Commissioner -IRD

Inland Revenue Act No. 24 of 2017 chargeability of Income tax Sri Lanka Inland Revenue 2018

Inland Revenue Act No. 24 of 2017 Imposition of Income Tax Chargeability -[Charging Provision (Sec. 2(1)] Income tax shall be payable for Each “year of assessment” By a “person” who has “taxable income” for that year; or a person who receives a “final withholding payment” during that year

Inland Revenue Act No. 24 of 2017 Definition “Person” means an individual or entity and includes a body of persons corporate or un-incorporate, an executor, nongovernmental organization and charitable institution.

Inland Revenue Act No. 24 of 2017 Source of Income Employment income ( Sec. 5) Business income (Sec. 6) Investment income ( Sec 7) Other income (Sec 8)

Inland Revenue Act No. 24 of 2017 Assessable Income (sec.4) For a resident person The income from employment, business, investment or other source “wherever the source arises” For a non-resident person The income from the employment, business, investment or other source to the extent that the “income arises in or is derived from a source in Sri Lanka”

Income Tax Payable Sec.2(2) Tax on taxable income xxx Tax on final withholding payment Total Income Tax payable xxx xxxx

Income Tax Base (Sec. 3 to 19) Assessable income from “Employment” Assessable income from “Business” xxxx xxxx Assessable income from “Investment” Assessable income from “Other sources” xxxx xxxx xxxx Less: Qualifying payments and reliefs Sec. 52 (xxx) Taxable income (Sec. 03) xxxxx

Tax Calculation (Sec.2(3)) Taxable income @ tax rates as per First Schedule xxxx Less: Any foreign tax credit (Sec . 80) (xxx) Any other tax credit allowed under the Act (xxx) Tax payable xxxx

Tax on Final Withholding Payments [Sec.2(4)] Final withholding payments @ tax rates as per First Schedule xxxx Final withholding payments (Sec. 88) Relieve a withholdee’s tax liability [Sec 88(2)] - Tax withheld from a final withholding payment by withholding agent - Liability of the withholder if no deduction is made [Sec 88(3)] - Liability of the withholdee if no deduction is made by the withholder [Sec 86(4)]

Inland Revenue Act No. 24 of 2017 business Income Sri Lanka Inland Revenue 2018

Inland Revenue Act No. 24 of 2017 Introduction “Business” has been defined to include: A trade, profession, vocation or isolated arrangement with a business character however short the duration of the arrangement; and A past, present or prospective business. Sri Lanka Inland Revenue 2018 12

Inland Revenue Act No. 24 of 2017 Trade Factors to be considered reference to trade 1. What is sold – Eg. Purchase of commercial quantities of product that cannot be used personally. 2. Length of ownership – If asset is held for a short period of time, it suggests trade rather than an investment. 3. Repetition – Repetition of transactions suggest a trade. 4. Supplementary work – Trade often process of works turn assets into saleable products. 5. Motivation activity – Trade require assets or conclude contracts with the intention of a making a profit. 6. Motivation for sale – Trades typically sell assets for the same reason they acquire, them, in order to make a profit. Sri Lanka Inland Revenue 2018 13

Inland Revenue Act No. 24 of 2017 Changes in the Year of Assessment – Section 20 Accounting Period:For year of Assessment Change in Accounting Period:With approval of the CGIR if think fit If fails to comply with a term and condition attached to approval, revoke an approval Sri Lanka Inland Revenue 2018 14 may

Inland Revenue Act No. 24 of 2017 Method of Accounting – Section 21 Inclusion and deduction shall be made according to general accepted accounting principle. Individual shall account for income tax purpose on cash basis in calculating individual’s income from an employment or investment. Individual or entity conducting business shall account for income tax basis an accrual basis. Other sources shall account either a cash or accrual basis whichever properly computes the person’s income. Sri Lanka Inland Revenue 2018 15

Inland Revenue Act No. 24 of 2017 Method of Accounting cont With approval of the CGIR method of accounting can be changed if CGIR shall be satisfied that the new method is necessary to properly compute the person’s income. Where method of accounting changes, adjustment shall be made in the year of assessment following the changes so that no item is omitted or taken into account more than once. Sri Lanka Inland Revenue 2018 16

Inland Revenue Act No. 24 of 2017 Cash Basis Accounting – Section 22 Under the cash basis accountinga. Derives an amount when payment is received by or made available, and b. Incurs an expense or other amount when it is paid. Sri Lanka Inland Revenue 2018 17

Inland Revenue Act No. 24 of 2017 Accrual basis Accounting – Section 23 Under the accrued basis accounting:a. Derives an amount when it is receivable by the person, and b. Incurs an expense or other amount when it is payable. Sri Lanka Inland Revenue 2018 18

Inland Revenue Act No. 24 of 2017 Accrual basis Accounting cont An amount shall be receivable by, When the person become entitled to received it, even if the time for discharge of the entitlement is postponed or the entitlement is payable by instalments. Sri Lanka Inland Revenue 2018 19

Inland Revenue Act No. 24 of 2017 Accrual basis Accounting cont An amount shall be treated as payablea. When all the event that determine liability have occurred b. The amount of the liability can be determined with reasonable accuracy c. But not before economic performance with respect to the amount occurs. Sri Lanka Inland Revenue 2018 20

Inland Revenue Act No. 24 of 2017 Accrual basis Accounting cont Economic performance occurs:a. With respect to the acquisition of services or assets, at the time the services or assets are provided; b. With respect to the use of an asset, at the time the asset is used; and c. In any other case, at the time the person makes payment in full satisfaction of the liability. Sri Lanka Inland Revenue 2018 21

Inland Revenue Act No. 24 of 2017 Accrual basis Accounting cont Economic performance occurs:a. With respect to the acquisition of services or assets, at the time the services or assets are provided; b. With respect to the use of an asset, at the time the asset is used; and c. In any other case, at the time the person makes payment in full satisfaction of the liability. Sri Lanka Inland Revenue 2018 22

Inland Revenue Act No. 24 of 2017 Business Income The following amounts shall be included in calculating the gains and profits of a person from conducting a business . a. Service fees; b. Consideration received in respect of trading stock; c. Gains from the realization of capital assets and liabilities of the business as calculated d. Amounts required to be included by the 2nd or 4th Schedule on the realization of the person’s depreciable assets of the business; Sri Lanka Inland Revenue 2018 23

Inland Revenue Act No. 24 of 2017 Business Income The following amounts shall be included in calculating the gains and profits of a person from conducting a business . a. Service fees; “Service fee” means a payment to the extent to which, based on market values, it is reasonably attributable to services rendered by a business of a person, but excludes interest, rent or a royalty. Section 195 Sri Lanka Inland Revenue 2018 24

Inland Revenue Act No. 24 of 2017 Business Income b. Consideration received in respect of trading stock; “Trading stock” means assets owned by a person that are sold or intended to be sold in the ordinary course of a business of the person, work in progress on such assets, inventories of materials to be incorporated into such assets and consumable stores; Section 195 Sri Lanka Inland Revenue 2018 25

Inland Revenue Act No. 24 of 2017 Business Income c. Gains from the realization of capital assets and liabilities of the business as calculated “Capital asset”– (a) means each of the following assets: (i) land or buildings; (ii) a membership interest in a company, partnership or trust; (iii) a security or other financial asset; (iv) an option, right or other interest in an asset referred to in the (b) excludes trading stock or a depreciable asset; Section 195 Sri Lanka Inland Revenue 2018 26 foregoing paragraphs; but

Inland Revenue Act No. 24 of 2017 Business Income d. Amounts required to be included by the 2nd or 4th Schedule of the person’s depreciable assets of the business; on the realization “Depreciable asset” – a. means an asset to the extent to which it is employed in the production of income from a business and which is likely to lose value because of wear and tear, or the passing of time; but b. excludes goodwill, an interest in land, a membership interest in an entity and trading stock; Sri Lanka Inland Revenue 2018 27

Inland Revenue Act No. 24 of 2017 Business Income Contd. e. Amounts derived as consideration for accepting a restriction on the capacity to conduct the business; f. Gifts received by the person in respect of the business; g. Amounts derived that are effectively connected with the business and that would otherwise be included in calculating the person's income from an investment; and h. Other amounts required to be included under this Act. Sri Lanka Inland Revenue 2018 28

Inland Revenue Act No. 24 of 2017 Business Income Contd. The following amounts should be excluded when calculating a person’s gains and profits from business. a. Exempt amounts and final withholding payments; and b. Amounts that are included in calculating the person's income from an employment. Sri Lanka Inland Revenue 2018 29

Inland Revenue Act No. 24 of 2017 Deductions Deductions will be discussed relevant to the all source of income, generally deduction of the Act falls in to three main categories General deductions (Section 10) Main deduction (Section 11) Specific deductions (Section 12-19) Sri Lanka Inland Revenue 2018 30

Inland Revenue Act No. 24 of 2017 General Deductions – Section 10 1. (a) No deduction shall be made in calculating a person’s income from employment [Sec.10(1)(a)] (b) Certain specific deductions are not allowable in calculating a person’s income [Sec.10(1)(b)] 2. A deduction for a payment shall not be allowed until the tax, if required, withheld has been paid to the Commissioner General. Sri Lanka Inland Revenue 2018 31

Inland Revenue Act No. 24 of 2017 General Deductions Cont 3. No deduction shall be allowed except as expressly permitted by the Act. 4. Where more than one deduction applies, the most specific deduction shall be applied even if that results in the denial(Rejection) of a deduction. Sri Lanka Inland Revenue 2018 32

Inland Revenue Act No. 24 of 2017 General Deductions - Section10 The following expenses shall not be deducted in computing a person’s income [S.10(1)(b)] [specific deductions ] Domestic expenses -Section.197. Sri Lanka Inland Revenue 2018 33

Inland Revenue Act No. 24 of 2017 Domestic expenses - Section 197 (1) Where an individual incurs expenditure in respect of himself, the expenditure shall be domestic expenditure to the extent that it is incurred In maintaining the individual, including in providing shelter as well as meals, refreshment, entertainment or other leisure activities; In the individual commuting (travelling) from home; In acquiring clothing, including shoes, for the individual, other than clothing that is not suitable for wearing outside of work; Sri Lanka Inland Revenue 2018 34

Inland Revenue Act No. 24 of 2017 Domestic expenses cont In paying any personal debts, including credit card debts, of the individual. In educating the individual, other than education that is directly relevant to a business conducted by the individual and that does not lead to a degree or diploma; or Sri Lanka Inland Revenue 2018 35

Inland Revenue Act No. 24 of 2017 Domestic expenses (2) Where another person incurs expenditure in making a payment to or providing any other benefit for an individual the expenditure shall be domestic expenditure except to the the extent that The payment or benefit shall be included in calculating the income of individual; The individual provides consideration of an equal market value for the payment or benefit; The amount of expenditure is so small as to make it unreasonable or administratively impracticable to account for it; Sri Lanka Inland Revenue 2018 36

Inland Revenue Act No. 24 of 2017 Domestic expenses (3)Expenditure referred to in subsection 1 and 2 include interest incurred with respect to money borrowed that is used in a manner referred to in those subsection. Sri Lanka Inland Revenue 2018 37

Inland Revenue Act No. 24 of 2017 General Deductions Tax payable under this Act or other taxes and levies specified by the Commissioner General of Inland Revenue (CGIR). Interest, penalties and fines payable in relation to breach of any written law. Expenditure in deriving exempt amounts or final WHT payments Sri Lanka Inland Revenue 2018 38

Inland Revenue Act No. 24 of 2017 General Deductions Cont Retirement contributions, unless those are included in calculating the income of an employee or consist of a contribution by an employer to approved funds by the CGIR (pension, provident or savings funds or provident or savings society) Dividends of a Company An amount transferred to a reserve or provision for expenditure or losses not yet incurred, but expected to be incurred in a future year of assessment Sri Lanka Inland Revenue 2018 39

Inland Revenue Act No. 24 of 2017 General Deductions Outlays or expenses for entertainment “entertainment” means the provision to any person of food, beverages, tobacco, accommodation, amusement(Enjoyment), recreation or hospitality of any kind”. Section195 Amounts incurred on lotteries, betting or gambling, other than amounts incurred from conducting a business of lotteries, betting or gambling Sri Lanka Inland Revenue 2018 40

Inland Revenue Act No. 24 of 2017 Main Deduction -Section11 In calculating income from business or investment, the following are deductible (a) Expenses to the extent they are incurred during the year; and (b) Incurred in the production of income. No deduction shall be allowed for an expense of capital nature. “Expenses of a capital nature” includes an expenses that secures a benefit capable of lasting longer than 12 months Sri Lanka Inland Revenue 2018 41

Inland Revenue Act No. 24 of 2017 Specific Deduction Interest Expenses- Section 12 Allowance for trading stocks - Section 13 Repairs and improvements – Section 14 R & D expenses and agricultural start up expenses - Section 15 Capital allowances and balancing allowances - Section 16 Losses on realization of business assets and liabilities - Section 17 Deductible amount of financial cost - Section 18 Business or investment losses – Section 19 Sri Lanka Inland Revenue 2018 42

Inland Revenue Act No. 24 of 2017 Interest Expenses – Section 12 The interest incurred by a person during the year under debt obligation of the person shell be deemed to be incurred in the production of income to the extend thata) The borrowed money was used to acquire an asset that is used during the year in the production of income; or b) The debt obligation was incurred in the production of income Sri Lanka Inland Revenue 2018 43

Inland Revenue Act No. 24 of 2017 Allowance for Trading Stock – Section 13 “Trading stock” means assets owned by a person that are sold or intended to be sold in the ordinary course of a business of the person, work in progress on such assets, inventories of materials to be incorporated into such assets and consumable stores Section195 The definition of “capital asset" and “depreciable asset" excludes Trading stock. However it depends on facts of the case. Calculation of trading stock as sub section 2 of section 13 Sri Lanka Inland Revenue 2018 44

Inland Revenue Act No. 24 of 2017 Allowance for Trading Stock The allowance shall be calculated as – Opening value of trading stock of the business for the Y/A ****** Plus: Expenses incurred during the on trading stock of the business **** ****** Less: Closing value of trading stock of the business for the year. Allowance for trading stock Sri Lanka Inland Revenue 2018 45 ****** ( ***)

Inland Revenue Act No. 24 of 2017 Allowance for Trading Stock Closing valve of trading stock shall be lower of – a. The cost of the trading stock at the end of the year b. The market value of the trading stock at the end of the year According to this comparison, cost of the trading stock shall be reset Sri Lanka Inland Revenue 2018 46

Inland Revenue Act No. 24 of 2017 Example - Allowance for Trading Stock ABC and company Sri Lanka Inland Revenue 2018 47

Inland Revenue Act No. 24 of 2017 Repairs and Improvements – Section 14 Expenses for the repair or improvement of depreciable assets shall be deducted irrespective of whether they are of a capital nature or not 48

Inland Revenue Act No. 24 of 2017 Definition “Depreciable asset” – a. means an asset to the extent to which it is employed in the production of income from a business and which is likely to lose value because of wear and tear, or the passing of time; but b. excludes goodwill, an interest in land, a membership interest in an entity and trading stock; Section 195 Sri Lanka Inland Revenue 2018 49

Inland Revenue Act No. 24 of 2017 Limitation for Deduction Assets categorized under Buildings, structures and similar depreciable assets (Class 4) - 5% for all other cases - 20% of the WDV of the asset at the end of previous year. Excess expense for which a deduction is not allowed shall be added to the depreciation basis of the asset. Sri Lanka Inland Revenue 2018 50

Inland Revenue Act No. 24 of 2017 Example – Repair & Improvements Company R runs a manufacturing business. During the following years of assessments it incurs expenditure as follows: - 2018/2019 : bought machine B for Rs. 2,000,000 - 2019/2020 : repairs and improvements to machine B Rs. 400,000 - 2020/2021 : repairs and improvements to machine B Rs. 200,000 Since the machine B is under class 3 , the deduction for repairs and improvements is limited to 20% of the depreciation basis of the machine B at the end of the previous Y/A Sri Lanka Inland Revenue 2018 51

Answer for Example – Repair & Improvements 2018/2019 2019/2020 2020/2021 1,600,000 1,200,000 80,000 400,000 200,000 1,600,000*20% 320,000 1,200,000*20% 240,000 320,000 200,000 80,000 Nil 2,000,000/5 400,000 1,600,000/4 400,000 1,280,000/3 426,666 1,600,000 1,200,000 853,334 WDV of Machine B at the beginning of the Y/A (Depreciation basis) Repair Exp. Allowable Allowed Not allowed Capital allowance WDV of Machine B at the end of the Y/A (Depreciation basis) 52

Inland Revenue Act No. 24 of 2017 Research and Development Expenses and Agricultural Start up Expenses – Section 15 Research and Development expenses and Agricultural start up expenses meeting the requirements of subsection (1) of section 11 may be deducted irrespective of whether they are of a capital nature or not. Sri Lanka Inland Revenue 2018 53

Inland Revenue Act No. 24 of 2017 Definition “Agricultural start up expenses” means expenses incurred by the person in – (a) opening up any land for cultivation or for animal husbandry; (b) cultivating land referred to in paragraph (a) with plants; (c) the purchase of livestock or poultry to be reared on land referred to in paragraph (a); or (d) maintaining tanks or ponds or the clearing or preparation of any inland waters for the rearing of fish and the purchase of fish to be reared in such tank, pond or inland waters, as the case may be; Sri Lanka Inland Revenue 2018 54

Inland Revenue Act No. 24 of 2017 Definition “Agricultural start up expenses” means expenses incurred by the person in – (a) Carrying on any scientific, industrial, agricultural or any other research for the upgrading of the person’s business through any institution in Sri Lanka (or for any innovation or research relating to high value agricultural products, by the person or through any research institution in Sri Lanka); or (b) The process of developing the person’s business and improving business products or process, which shall be beneficial to Sri Lanka, but shall exclude expenses incurred that are otherwise included in the cost of an asset under this Act. Sri Lanka Inland Revenue 2018 55

Inland Revenue Act No. 24 of 2017 Capital Allowance and Balancing Allowance Section 16 A person is entitled to claim capital allowances if such person is the owner of the depreciable asset; and uses them at the end of a year of assessment in the production of the person’s income from a business; 56 -

Inland Revenue Act No. 24 of 2017 Owned and Used - Temporary disuse Capital Allowance Example: One of the printing machines of Company “A” is broken down and the Company has had substantial problem of getting it repaired because they had to order parts from the European manufacturer. Hence the Company “A” had to wait 14 months. Despite the 14 months during which the printing machine was not in use, Company A was actively pursuing its repair and did succeed in having the machine put back into operation. Company “A” may continue to claim capital allowances during the time it took to have the printing machine repaired. 57

Inland Revenue Act No. 24 of 2017 Owned and Used Capital Allowance Example: Company A runs a hotel. It commissioned Company Z to construct a new hotel in Colombo. The contract price is Rs. 20,000,000 and the construction period is two and a half years. Company A is required to pay the contract price in instalments as follows, - deposit - 10%, - after the foundations are laid - 20% - after lock-up - 40% - on completion - 30%. Is it eligible to claimed the Capital allowances 58

Inland Revenue Act No. 24 of 2017 Capital Allowance Shall be calculated - According to the straight line method - According to the second, fourth or sixth schedules Full capital allowances will be granted for the year of acquisition Capital allowance will not be granted for the year of disposal Shall not be deferred to a later year of assessment 59

Inland Revenue Act No. 24 of 2017 Capital Allowance No Capital Allowance Shall be granted in respect of a road vehicle other than - a commercial vehicle, - a bus or minibus, - a goods vehicle; - or a heavy general purpose or specialised truck or trailer; Definition of “Commercial Vehicle” mean, - a road vehicle designed to carry loads of more than half a ton or more than 13 - a vehicle used in a transportation or vehicle rental business. 60 passengers; or

Clas s Depreciable Assets Number of Years 1 computers and data handling equipment together with peripheral devices 5 2 buses and minibuses, goods vehicles; construction and earthmoving equipment, heavy general purpose or specialised trucks, trailers and trailer-mounted containers; plant and machinery used in manufacturing 5 3 railroad cars, locomotives, and equipment; vessels, barges, tugs, and similar water transportation equipment; aircraft; specialised public utility plant, equipment, and machinery; office furniture, fixtures, and equipment; any depreciable asset not included in another class 5 4 buildings, structures and similar works of a permanent nature 20 5 intangible assets, excluding goodwill The actual useful life of the intangible asset, or where the intangible asset has an indefinite useful life, 20.

Inland Revenue Act No. 24 of 2017 Calculation of Capital Allowance Formula for calculating capital allowance A/B A -The depreciation basis of asset at the end of the year of assessment B -Number of years (provided in the fourth schedule) 62

Inland Revenue Act No. 24 of 2017 Allowance Depreciation basis of Depreciable Asset The depreciation basis of the asset at the end of the previous year of assessment and (could be the cost or WDV) Amounts added to the depreciation basis of the asset during the year of assessment including the excess expense of repair and improvements referred to in section 14 for which a deduction shall not be allowed as a result of the limitation. 63

Inland Revenue Act No. 24 of 2017 Example :Repair & Improvements and Capital Allowances Example: Company runs a manufacturing business. During the following years of assessments it incurs expenditure as follows: - 2018/2019 : bought machine B for Rs. 2,000,000 - 2019/2020 : repairs and improvements to machine B Rs. 400,000 - 2020/2021 : repairs and improvements to machine B Rs. 200,000 Since the machine B is under class 3 , the deduction for repairs and improvements is limited to 20% of the depreciation basis of the machine B at the end of the previous Y/A 64

Inland Revenue Act No. 24 of 2017 2019/2020 2020/2021 1,600,000 1,200,000 80,000 400,000 200,000 1,600,000*20% 320,000 1,200,000*20% 240,000 320,000 200,000 80,000 Nil 2,000,000/5 400,000 1,600,000/4 400,000 1,280,000/3 426,666 1,600,000 1,200,000 853,334 2018/2019 WDV of Machine B at the beginning of the Y/A (Depreciation basis) Repair Exp. Allowable Allowed Not allowed Capital allowance WDV of Machine B at the end of the Y/A (Depreciation basis) 65

Inland Revenue Act No. 24 of 2017 An Assessable Charged is included or Balancing Allowance is granted Where a depreciable asset of a person is realised, when calculating the person’s income; (a) an assessable charge is included (profit) or (b) a balancing allowance is granted (loss) 66

Inland Revenue Act No. 24 of 2017 An Assessable Charged is included Example: Company A runs a property rental business and owns a building of apartments for rental. At the start of year 1, the balance in Company A's class 4 is Rs. 30,000,000, i.e. the balance at the end of the previous year less the depreciation allowance granted for that year. Company A is expecting to sell off a large number of the apartments in the building except for a few select apartments. As a result, during year 1 it receives Rs. 50,000,000 as proceeds from the sales. Calculate the assessable charged or Balancing allowance for Y/A 2018/19 67

Inland Revenue Act No. 24 of 2017 Balancing Allowances (Loss) Balancing allowances are – made in respect of depreciable assets (a) (i) realised during a year of assessment; and (ii) in respect of which capital allowances have been granted in that year or an earlier year; and (b) Calculated in accordance with the provisions of the second, fourth or sixth schedule to this act. 68

Inland Revenue Act No. 24 of 2017 An Assessable Charged is included or Balancing Allowance is granted Example: Company “R “sells office furniture at the price of Rs. 700,000 and at the time of disposal the written down value of the asset is Rs. 1,000,000. With respect to the office furniture, Company “R” will be granted a deduction in the amount by which the written down value of the asset exceeds the proceeds of sale, i.e. Rs. 300,000. Sale proceed WDV Rs. 700,000 Rs. 1,000,000 Balancing allowance (Loss) Rs. 300,000 Rs. 300,000 is allowed as a deduction when calculating company R’s business income 69

Inland Revenue Act No. 24 of 2017 Capital Allowance for Leasing Assets Where an asset is leased under the finance lease, the lessor shall be treated as transferring ownership of the asset to the lessee. Accordingly, the lessee is entitled to deduct capital allowance in relation to the assets obtained under finance leasing. Substance Vs. From - No. 10 of 2016 –From - No.24 of 2017 - Substance 70

Inland Revenue Act No. 24 of 2017 An Assessable Charged is included or Balancing Allowance is granted Example: Company “R “sells office furniture at the price of Rs. 700,000 and at the time of disposal the written down value of the asset is Rs. 1,000,000. With respect to the office furniture, Company “R” will be granted a deduction in the amount by which the written down value of the asset exceeds the proceeds of sale, i.e. Rs. 300,000. Sale proceed WDV Rs. 700,000 Rs. 1,000,000 Balancing allowance (Loss) Rs. 300,000 Rs. 300,000 is allowed as a deduction when calculating company R’s business income 71

Investment incentive as Second schedule A person who invests in Sri Lanka (other than the expansion of an existing business) during a year of assessment shall be granted enhanced capital allowances, in addition to the capital allowances computed under the Fourth Schedule. 72

Enhanced Capital Allowance as Second schedule Condition Limitation Capital allowance % 1. Used in a part of Sri Lanka other than the Northern Province On depreciable assets other than intangible assets USD 3 million -USD 100 million 100% 2. Used in a part of Sri Lanka other than the Northern Province On depreciable assets other than intangible assets - exceeds USD 100 million 150% 3. Used in the Northern Province On depreciable assets other than intangible assets - exceeds USD 3 million 200% 4. State-owned company that are On assets or shares - exceeds USD 250 150% used in a part of Sri Lanka million 73

Condition for claiming the Enhanced Capital Allowance Capital allowances arising above paragraphs of above table with respect to a particular year of assessment cannot be accumulated with another paragraph and shall be taken in that year and shall be deferred to a later year of assessment. 74

Inland Revenue Act No. 24 of 2017 Temporary Concession as Sixth schedule A person who invests in Sri Lanka (other than expansion of existing business) on depreciable assets mentioned in the following table during a year of assessment shall be granted enhanced capital allowances computed in accordance with this paragraph, in addition to the capital allowances computed under the Forth Schedule. 75

Enhanced Capital Allowance as Sixth schedule Condition 1. in a part of Sri Lanka other than the Northern Province 2. in the Northern Province Limitation Depreciable assets Class 1 and class 4 assets and plant or machinery that are used to improve business processes or productivity and fixed to the business premises. 76 Capital allowance % 100% up to USD 03 million 200%

Temporary Concession as Sixth schedule Conditions Claiming of capital allowances cannot be deferred to a later year of assessment. Deduction of capital allowances under this Schedule shall expire three years after it becomes effective. 77

Losses on Realization of Business Assets and Liabilities – Section 17 In calculating the person’s income from business, loss from the realization of asset and liabilities shall be deducted. Assets Capital assets of a business used in the production of income from business. Liability Debt obligation incurred in borrowing money – money used or asset purchased Other liability - the liability was incurred in the production of income from the business. 78

Definition “Capital asset”– (a) means each of the following assets: (i) land or buildings; (ii) a membership interest in a company, partnership or trust; (iii) a security or other financial asset; (iv) an option, right or other interest in an asset referred to in the paragraphs; but (b) excludes trading stock or a depreciable asset; Section 195 79 foregoing

Deductible amount of Financial cost – Section 18 The amount of financial costs deducted in calculating an entity’s income for a year of assessment shall not exceed the amount of financial costs attributable to financial instruments within the limit. This rule does not apply to Financial Institutions from conducting a business or investment and individuals (entity excludes individual). 80

Definition “Financial instrument” means (a) (i) a debt claim or debt obligation; (ii) a derivative instrument; (iii) a foreign currency instrument; and (iv) any other instrument prescribed by regulations or, in the absence of regulations, treated as a financial instrument by generally accepted accounting principles; but (b) except to the extent as may be prescribed by regulations, excludes a membership interest in an entity. Section 198 81

Limitation for Financial cost Formula: AxB Where: ‘A’ - total of the issued share capital and reserves of the entity ‘B’ - (a) in the case of a manufacturing entity, the number 3; (b) in the case of an entity other than a manufacturing entity, the number 4. 82

Limitation for Financial cost For Manufacturing Entities Allowable Finance Cost attributable to financial instruments (Total Cost of Financial Instruments) X [(Total of the issued Share Capital and reserves) X 3] For Other Entities Allowable Finance Cost attributable to financial instruments (Total Cost of Financial Instruments) X [(Total of the issued Share Capital and reserves) X 4]

Limitation for Financial cost Example: Company B is a garment factory and incurs interest expense (for what) amounting to Rs. 4,500,000 during the year of assessment 2018/2019. Balance Sheet of the company as at 31.03.2019 revealed as follows. Stated Capital Rs. 6,000,000 Revenue Reserves Rs. 4,000,000 Long Term Loans Rs.40,000,000 Calculate the allowable interest expense according to thin capitalization rule.

Business or Investment Losses – Section 19 In calculating the income of a person from a business following shall be deducted:– (a) an unrelieved loss of the person for the year from any other business; and (b) an unrelieved loss of the person for any of the previous six years of assessment from the business or any other business. 85

Business or Investment Losses Conditions The person may choose the income calculation or calculations in which an unrelieved loss or part of the loss is deducted. Notwithstanding the provisions of subsections (1) and (2), where a person makes a loss and if the loss were a profit it would be taxed at a reduced rate, the loss shall be deducted only in calculating income taxed at the same reduced rate, If the loss were a profit and the profit would be exempt, the loss shall be deducted only in calculating exempt amounts. 86

Business or Investment Losses – Section 19 Deduction Income Source Criteria Eligible Loss Business income Unrelieved business Loss of any other business previous six years Investment Income Unrelieved business Loss Investment Loss 87 Loss Income Reduced rate Same reduced rate, Lower reduced rate, Exempt Exempt Exempt

Definition “Loss” means of a person for a year of assessment from a business or investment shall be calculated as the excess of amounts deducted in accordance with this Act (other than under this section or subsection (5) of section 25) in calculating the person’s income from the business or investment over amounts included in calculating that income; and “Unrelieved loss” means the amount of a loss that has not been deducted in calculating a person’s income under this section or subsection (5) of section 25. 88

Applicability of Specific Deductions Section Expense Business Investment 12 Interest 13 Trading stocks - 14 Repairs and improvements - 15 R & D and agricultural start up - 16 Capital allowances - 17 Losses on realisation of business assets and liabilities - 18 Deductible amount of financial cost 19 Business or investment losses

Reversal of amount including bad debts Reversal Where a person deducts an expense in calculating the person’s income and the person later recovers the expense, the person shall, at the time of recovery, include the amount recovered in calculating the person’s income. Disclaimer or Write off The person may, at the time of disclaimer or write off, deduct the amount disclaimed or written off in calculating the person’s income. a person can disclaim the entitlement to receive an amount or write off a debt claim as bad if the person has taken reasonable steps in pursuing payment and the person reasonably believes that the entitlement or debt claim will not be satisfied. 90

Limitation for Financial cost Example: Company which has a book profit of Rs. 20,100,000 for the year ended 31.03.2019, has made following transactions. - Made the provision for doubtful debts account for the year ended 31.03.2019 Rs.2,200,000. Out of which a sum of Rs. 800,000 represents specific provision and the balance of Rs. 1,000,000 is general provision. - It has written off a total sum of Rs. 800,000 out of the general provision made To Trade debts of Rs. 500,000 To Staff loans of Rs. 300,000 Make the relevant tax adjustments for the year of assessment 2018/2019.

Calculation of Assessable Income from Business Income from business xxxx Less : Exempt amounts xxx : Final withholding payments xxx (xxx) Liable Income from business Less : Allowable deductions Assessable Income from business 92 xxxx (xx) xxxx

Business Income 93