This article is the second part of the series "Income tax of a Business Name - the nitty gritty". Having determined the appropriate revenue authority and the assessment period, the following steps should be considered in calculating any tax due.
Step 1: Determine your profit for the year. In the absence of proper entries and documentation, the Business Name may be exposed to a best of judgement assessment by the relevant tax authority.
Step 2: Identify expenses or deductions not allowed in ascertaining the income of the individuals. Where the law provides that certain expenses must not be recognized in determining the taxable profit, appropriate adjustments need to be made against the income determines in step 1 above.
Personal Income Tax Act (PITA) gives guidance on expenses that are not allowed and specifically outlines some examples which are non-exhaustive. The tax authority checks to see that expenses are incurred wholly, exclusively, reasonably and necessarily for the business (called WERN test). Any expense that fails the WERN test, will not be allowed for tax purposes and will be added back to the profit to be taxed.
Step 3: Identify non-taxable income. In this step, deduct income that should not be taxed either because it is exempted under the law or as part of any adjustment of an amount not subject to tax. A typical example of such income could be a capital receipt or investment income that has suffered tax at source.
However note that such non-taxable income may have different tax implications under other tax laws such as Capital Gains Tax Act.
Step 4: Claim of allowances on assets. After step 3 above, you proceed to ascertain capital allowances. Capital allowances are reliefs granted on certain qualifying capital expenditure (assets) at specified rates over a period of time. Also, for businesses that may be located in rural areas, the tax law grants investments credits/incentives for certain investments in basic infrastructure, which government ordinarily should have provided in those areas. This includes investment in water, electricity and roads.
The capital allowance so determined is deducted from the result obtained in step 3. The results under this step can be divided among other members of the Business Name in agreed proportions where it is owned by more individual.
Step 5: Add income from other sources. An individual is expected to add earned income from other sources outside the core operations of the Business Name. Most often than not, the income could be from passive income or other investments by the individual. These unearned incomes, gross of withholding tax, are then added to the result in step 4 to give what is called statutory total income.
Step 6: Available reliefs and statutory deductions are subtracted from the result obtained in step 5 to the extent of participation by the Business Name to arrive at the taxable profit.
Step 7: The following graduated tax rates are applied against the taxable profit obtained in step 6 as follows:
- First N300,000 @ 7%
- Next N300,000 @ 11%
- Next N500,000 @ 15%
- Next N500,000 @ 19%
- Next N1,600,000 @ 21%
- Above N3,200,000 @ 24%
For example, if XYZ & Son's taxable profit is N700,000, the tax to be paid will be N69,000 as shown in the table below:
First N300,000 @ 7%
Next N300,000 @ 11%
Next N100,000 @ 15%
Summarily, we have identified that taxation of individual is not different from a Business Name. Also, we have assisted you to get understanding of how a Business Name's income tax is determined in line with the provisions of PITA.
Taxing authorities need widen the tax net for revenue generation. Hence, there is a high drive to capture as many tax payers using the law and in some cases, exploiting the ignorance of taxpayers. Consequently, a Business Name should arm itself with records so as to determine or defend an expense in the event of tax audits or scrutiny by tax authorities. Determination of income or loss is at the discretion of the tax authorities. Hence, it is imperative and best practice for businesses to maintain separate and adequate records of their incomes and expenses as this will form the basis for enjoying tax incentives within the ambit of the law.