Page 120 - DCOM508_CORPORATE_TAX_PLANNING

Unit 5: Computation of Taxable Income of Companies

2. Step 2: From the gross total income, prescribed ‘deductions’ under Chapter VI A are Notes
made to get the ‘net income’. Generally, all expenses incurred for business purposes are
deductible from taxable income; given that the expenses must be wholly and exclusively
incurred for business purposes and also that the expenses must be incurred or paid during
the previous year and supported by relevant papers and records. But expenses of personal
or of capital nature are not deductible.

Capital expenditure is deductible only through depreciation or as the basis of property
in determining capital gains or losses. Deductions shall also be allowed in respect of
depreciation, as per Section 32 of Income Tax Act, of tangible assets such as machinery,
buildings, etc and non-tangible assets such as know-how, patents, etc, which are owned
by assessee and used for the purpose of business profession. Depreciation is deducted
from the written-down value of the block of assets mentioned under Section 43 of the Act.
However, where an asset is acquired by assessee during the previous year and is put to
use for business or profession purpose for a period of less than 180 days, the deduction in
respect of such assets shall be restricted to 50% of the normal value prescribed for all block
of assets.
But no deduction shall be allowed in respect of any expenditure incurred in relation to
income which does not form part of total income.
3. Step 3: Tax liability is computed on the ‘net income’ that is chargeable to tax. It is done
either on accrual basis or on receipt basis (whichever is earlier). However if an income is
taxed on accrual basis, it shall not be taxed on receipt basis. From the tax so computed, tax
rebates or tax credit are deducted.
Calculating Companies Taxable Income: The key role played by any tax accountant is to calculate
a company’s taxable income. The taxable income of a company can be calculated using the
following formula:
Taxable income = Assessable income – Allowable deductions.
This formula applies to all entities, whether they are people known as real entities, or companies,
partnerships and trusts all referred to as artificial entities. We use a company here for simplicity

as companies are by far the most common of the artificial entities for which taxable income
calculations are carried out in practice. We also use the company because they typically have

accounting records from which the operating profit can readily be determined.
The taxable income calculation is quite simple. It is as follows:
Taxable income = Operating profi t (+ or -) permanent differences + Timing additions – Timing
subtractions (+ or -) future timing differences
Where;

1. Operating profit = Revenue – Expenses.
2. Permanent differences = accounting revenue items which are not income for tax law
purposes OR accounting expenses which are not deductions for tax law purposes. Some
common examples include entertainment or non-assessable dividends. Many of these
items are listed in Division 26 of the 1997 Income Tax Act.
3. Timing additions = accounting expenses which are not yet tax deductible. Some common
examples include provisions for doubtful debts and annual leave.

4. Timing subtractions = accounting revenue items which are not yet assessable income like
revenue in advance, or accounting assets which are immediately deductible for tax law
purposes
5. Future timing differences = accounting expenses which must be deducted over a prescribed
time period in accordance with the tax law like borrowing costs.

LOVELY PROFESSIONAL UNIVERSITY 115