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The measurement of business taxable income

The measurement of business taxable income

BUSINESS income can be defined as any earned gross income realised from an entity’s operations. For tax purposes, business income is treated as ordinary income. Allowable business expenses and losses are deducted from the gross income to arrive at the taxable profits. Gross income means all income from whatever source derived by the business. In business context, gross income consists primarily of the revenues derived from sale of goods or performance of services in the regular course of a firm’s commercial activities.

It should also be noted that Gross income also includes revenues generated by a firm’s invested capital, such as interest, dividends, and rents. The concept of gross income is broad enough to encompass other, less commonplace, increases in wealth that result from business transactions.

The Income Tax Act 2004 (CAP 332 R.E 2019) under section 8, defines a person's income from a business for a year of income as gains or profits from conducting business and should include service fees; incomings for trading stock; gains from the realisation of business assets or liabilities of the business, amounts derived as consideration for accepting a restriction on the capacity to conduct the business; gifts and other ex gratia payments received by the person in respect of the business, 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 the amounts of fringe tax benefit or advantage quantified under section 27 if the Income Tax or other amounts not taxable in the hands of the employees of the business. However, exempt amounts and final withholding payments; and amounts that are included in calculating the person's income from any employment should be excluded in calculating business income for tax purposes.

One of the mostly overlooked areas in measuring busines income is the cancelation of debts. Let’s take a practical example to illustrate how cancellation of indebtedness income should be treated.

Assume Company XYZ Limited has a 15,000,000/- (Tanzania fifteen million shillings) overdue account payable to one of her major suppliers of raw materials that XYZ Limited uses in its manufacturing process. The supplier knows that company XYZ limited is having severe cash flow problems due to Covid-19 impact on her sales but is eager to settle the account as quickly and advantageously as possible. After some negotiation, both parties agree that XYZ limited will pay 10,000,000/- (Tanzania ten million shillings) cash in full settlement of the account payable. Because company XYZ limited extinguished a 15,000,000/- (Tanzania Fifteen million shillings) liability with only 10,000,000/- (Tanzania ten million shillings) of assets, then its net worth has increased by 5,000,000/- (Tanzania five million shillings), an accession to wealth that XYZ limited must account for as current year income that should be subject to tax.

Businesses can deduct most of their routine operating expenses incurred wholly for the production of their busines incomes in arriving at their taxable incomes. Businesses can also deduct cost of assets acquired for long term in the production of business income, however, such asset cost recovery deductions are generally spread over some extended period of years except where there are special agreements that allow for immediate or hundred percent deduction of such asset costs. Because the tax legislation allows business to deduct expenses wholly incurred in the production of taxable income and costs incurred in revenue generating activities, the corporate tax is therefore imposed on net profit rather than gross receipts.

Companies must measure their taxable income every year and pay tax on an annual basis. The income tax Act 2004 (CAP 332 R.E 2019) as amended from time to time, gives businesses considerable latitude with respect to the 12-months period over which to measure income. It should be noted that, for purposes of paying tax, the 12 calendar months don’t necessarily have to run from January to December. A business entity can request for its tax calendar to start from a preferred calendar month and run for 12 months from the chosen calendar month.

The general rule is that a business’s taxable year corresponds to its annual accounting period or financial statements. If a business entity keeps its financial books and records on a calendar year, it measures taxable income over the same January through December period. If a business entity keeps its financial books and records on a fiscal year (any 12 months period ending on the last day of any month except December), it will use this fiscal year as its taxable year.

The choice of a calendar or fiscal year is usually dictated by the business’s operating cycle. Businesses want to close their books and calculate their profits at the end of a natural cycle of business activity. For example, a retail leather company might find that March 31 fiscal year -end results is the most accurate reflection of an operating cycle that peaks during the holiday season and reaches its lowest point before beginning of the Easter holidays and hence prefer the fiscal year.

Changing a Taxable year

As a general rule, a new business entity establishes its taxable year by filing an initial tax return on the basis of such year. Generally, the year of income for every business is the calendar year. The initial return reflects taxable income or loss from the date business operations begun until the end of the year, as a result the initial return typically reflects a short period of less than 12 months. After establishing a taxable year, a business can change its fiscal year

The business entity may apply, in writing, to the Commissioner for approval to change the entity's year of income from the calendar year, or from a twelve-month period previously approved by the Commissioner to another twelve-month period. Where the entity shows a compelling need to change the entity's year of income, the Commissioner may, by notice in writing, approve the application subject to any conditions as the Commissioner prescribes. The Commissioner may, by notice in writing, revoke an approval granted to an entity.

Where an entity's year of income changes, the period between the end of its previous year of income and the beginning of its new year of income will be another year of income of length of up to twelve months, or to eighteen months subject to the approval of the Commissioner.

The year of income for every foreign permanent establishment should be the same as the year of income of its owner.

The year of income for every non-resident partnership, trust or corporation should be the period, not exceeding twelve months, for which the entity makes up its accounts or, if it has no such period, the calendar year. The initial year of income of a business entity is the period of twelve months or less or subject to the approval of Commissioner eighteen months or less from the time the business starts to exist until the end of the business’s year of income.

This requirement has particular significance when a business starts and wants to keep records on a fiscal year basis. When the business has sound reason for changing its annual accounting period, the Tanzania Revenue Authority usually grants permission for the business to make a corresponding change in its taxable year. If the business lacks convincing reasons, the Tanzania Revenue Authority may withhold permission for the change. In those cases where the Tanzania revenue Authority grants permission, the business files a longer period return to accomplish the change.

  • The writer, Godvictor Lyimo is the President of Tanzania Association of Accountants (TAA), reachable via godvictorl@yahoo.co.uk, Phone: 078751401.
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