Handout - 1

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA

Executive Diploma in Accounting & Finance
INCOME TAX - Y.A. 2010/11
SOURCES OF INCOME (Income chargeable with Tax)

Profits From any Employment -

• Meaning of employment, Service contract, Contract of service Vs.

Contract for services.
• Employer - employee relationship.
• Exclusions and inclusions.

• Statutory definition - (Section 4)

(a) i. wages, salary, allowance, leave pay, fee, pension, commission,
bonus, gratuity. perquisite or any other payment in money
(received in the course of employment)
ii. value of any benefits (including family members)
ii. any payment to any other person for the benefit of the employee
(including family members)

(b) value of any conveyance or a grant to purchase one

(c) i. retiring gratuity, commuted pension.

ii. approved PF balance (including Trust Fund).
iii. regulated PF balance.
iv. compensation for loss of employment.

(d) Rental value of any place of residence provided by the employer.

(e) Sale of shares given by the employer as a benefit.

• Re-imbursement of expenses, Arrears and Advances.

• Allowable expenses
• Valuation of benefits (Items specified by the CGIR)
• Exemptions
• PAYE scheme
• Employment income of non-residents (Section 85 of Act No. 10 of
2006)
• Public sector employees including corporation employees.

Terminal Benefits (Section 4(1) (c) )

The concessionary tax rates are applicable to these benefits only if the
relevant scheme of payment is uniformly applicable to all employees.

Otherwise the normal tax rates will be applicable to these benefits as well.

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However the compensation for loss of employment which is not uniformly
applicable will be taxed at 20% maximum, on or after 01.04.2002.

Any retiring gratuity in excess of Rs. 1.8 m. or average salary for last 3 years
into number of years of service will be taxed at normal tax rates and the
concessionary rates will be applicable only up to Rs. 1.8 m. or the average
monthly salary for last 3 years into number of years of service, which ever is
higher.

The amount of retiring gratuity relating to the period of service in a public

corporation which has converted into a public company under the
"Conversion of Public Corporations or GOBUs into Public Companies Act No.
23 of 1987" will be excluded in the computation of the taxable portion of such
retiring gratuity.

Retirement benefits paid by Public Corporation (Profit making) relating to the

period up to 01.04.1997 will also be excluded.

Retirement benefits paid by other Public Corporation will be exempt from tax.

Compensation for loss of office/employment under any VRS or any scheme

approved by the Commissioner of Labor will be exempt. However, with effect
from 01.04.2006 any such compensation in excess of Rs. 2 m. will not be
exempt.

Rental Value (Special Cases)

Rental value of a residence situated in unrated areas will be limited to the

lower of -
the rent paid by the employer or Rs. 36,000/=

Rental value of estate bungalows will be limited to the lower of -

the rent paid by the employer or Rs. 24,000/=

If the residence provided by the employer is furnished then the additional

rental value should be considered. The additional amount to be assessed will
be the lower of:

1. 2 ½% of normal profits from employment.

2. Rs. 18,000/-

• Changes w.e.f 01.04.2011

Income from immovable property

This will include the income from land & buildings. The following sources of
income are relevant.
1. Net Annual Value (NAV)
2. Rent (Business Income for companies)
3. Occupier's income
4. Premiums
5. Other sources

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NAV -
This is only a benefit. This income is considered when the owner occupies the
building or someone else occupies it on behalf of the owner. Usually, the
calculation of NAV will be based on the Rating Assessment made by the local
authority. This is also called the "Annual Value".

E.g.: Annual Value - Rs. 80,000

Less - 25% - Rs. (20,000)
NAV - Rs. 60,000

The 25% allowance is for repairs and all other expenses. However, NAV will
not be considered if the building is used for any trade, business, profession or
vocation by the owner.
• Apportionment of NAV.
• Exemptions.

Rent -
This can be considered under 2 categories.
i. Pure rent (rent income)
ii. Income from furnished houses (other income)

Rent Income - This is calculated on the basis of gross rent receivable and
recoverable.

e.g.: Gross rent - Rs. 60,000

Less - rates paid - Rs. (9,000)
- Rs. 51,000
Less - 25% - Rs. (12,750)
-------------------
Net rent - Rs. 38,250
==========

According to the Inland Revenue Act the income from land and buildings
should not be less than the NAV of such land and buildings. Therefore, the
net rent as calculated above should be compared with the NAV. (However, if
the building is under rent control this comparison is not necessary). If the net
rent is less than the NAV, and amount equal to NAV should be considered as
rent income, subject to any portion considered as occupier's income and any
adjustment for any vacant period.

e.g.: If the rating assessment of the above building is Rs. 60,000 the NAV will
be Rs. 45,000. But the net rent is only Rs. 38,250. Therefore Rs. 45,000
should be considered as rent income.

• Any key money received should be considered under premiums.

• Exemptions.
• Rent as business income.

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Occupier's Income

This is also a benefit. This benefits accrues to the tenant of a building when
the gross rent paid is less than the NAV of such building. The difference
between the NAV and the gross rent will be assessed as occupier's income.
However, if the building is used for any trade, business, profession, vocation
or as a residence of an employee which was provided by an employer, the
occupier's income (if any) will not be considered.

Income form furnished houses -

1. Holiday bungalows
2. Other furnished houses
3. Buildings with additional facilities.

In the above situations the importance is that the amount received by the
landlord is apportioned between the rent and other charges. However, in
case of holiday bungalows only the NAV and other income will be considered.
In all theses cases the relevant sources will be Rent or NAV and income from
any other sources.

Holiday bungalows -

Since these buildings are kept for the owner's occupation the NAV should be
considered as one source of income. In addition to the NAV the income from
any other source should be computed on the rent received as follows :
e.g.: A holiday bungalow in Nuwara Eliya has been given on rent for 6 months
at Rs. 6000/= per month. The rating assessment is Rs. 30,000/= and the
rates payable at 25%. The owner has incurred the following expenses as well:

Brokerage - Rs. 1,000

Caretaker - Rs. 6,000
Repairs - Rs. 10,000 (building)
Repairs - Rs. 2,000 (furniture)
Rates paid - Rs. 7,500
Refrigerator - Rs. 15,000
Replacement of Furniture - Rs. 6,000

The calculation of income from the furnished letting will be as follows :

Gross rent (6000 x 6) - Rs. 36,000
Less - Brokerage - Rs. 1,000
Caretaker - Rs. 3,000
Repairs - Rs. 2,000
Furniture - Rs. 6,000
---------------- Rs. (12,000)
Deduction of R.V. for the period let (37,500 x ½) - Rs. (18,750)
----------------
Income from any other sources - Rs.
5,250
=========

Why not all expenses are allowed ?

Why no depreciation on capital expenditure ?
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What will happen if there is a loss ?

Other furnished houses -

The main difference from holiday bungalows is that no NAV is assessable in

these cases. Only the rent income and income from any other sources will be
considered. For this purpose total amount should be apportioned between
rent and other charges. The rent income will be calculated in the normal
manner using the gross rent. The calculation of income form any other source
will be similar to a holiday bungalow (However, no deduction of proportionate
R.V)

Building with additional facilities -

Here again the rent proper and the charges for other facilities should be
apportioned and the normal rent income calculation to be done using rent
proper. Income from any other source to be calculated in the same way as
explained above, using the charges for other facilities.

WHT on rent income -

Commercial rent - Rs. 50,000 per month or Rs. 500,000 per year or more per
building -
WHT rate - 10% (only up to 31.03.2011)

Dividend Income
Forms of dividends - Money or an order to pay money
- Shares in ay other company.
- Debentures in that company or any other company.

"Bonus Share" is not a dividend unless the return of capital on such a share is
made within 6 years from the date of capitalization. Any other "return of
capital" is also not a dividend.
Dividend income arises on the date of declaration.

Statutory Income = Gross Dividend

Gross dividend means the amount of the dividend declared before deduction
of tax. In case of dividend received from another company and distributed
the amount received is the gross dividend. Resident companies shall deduct
tax from dividends declared except in the following situations. With effect
from 01.04.2002 all companies including QPCC are liable to deduct tax from
dividends.

• declared out of tax exempt profits where the dividend is exempt under
section 10.
• declared out of dividend received after tax deduction from other
companies.
• declared not in the form of money or an order to pay money
• declared to any person exempt under section 7(a) or (c) of Act No. 10 of
2006
• declared by or to a Unit Trust/Mutual Fund
• declared to "Api Wenuwe Api Fund"
• declared to Registered Co-op Societies.

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The rate of tax is 10%

• Treatment of inter-company dividends.

• Dividends deemed to be distributed - S. 61(b)(ii) or S. 66 of Act No. 10 of
2006.
• Foreign Company dividends - net income subject to Double Tax
Agreements.
• Exempt dividends - (Section 10)
• Final tax (WHT) on dividends.
• Dividends as income from trade or business.
• Taxable dividends without tax deductions.

INTEREST INCOME
In computing income from interest the basis of calculation (i.e. - whether
interest due or interest received, to be considered) is important. The relevant
agreement should be interpreted carefully to ascertain this fact. Merely
because an interest bearing deposit is a long term deposit one cannot say
that the interest does not accrue. The proper question is that whether any
interest is payable before the maturity of the deposit or not. Mere
arrangements to receive interest on maturity is not conclusive.

However, certain types of investments, such as treasury bills, government

securities etc. are considered under cash basis.

Special Cases :
1. Interest on "compensation" receivable. This is applicable to any interest
due on compensation payable by the Government, Local Govt. or a
Corporation on account of any acquisition of property. Such interest is
assessable in the year of receipt and special tax rate (10%) is applicable.
WHT is also applicable.

2. Interest on extended deposits - Here again interest is assessable when

the deposit is matured. Maximum tax rate is 10%. WHT is applicable.

3. Interest payable on loans granted by persons outside Sri Lana - Tax rate
is 15%

• WITHHOLDING SYSTEM - Govt. securities - Primary Dealers

(01.04.2002)
- Secondary Market (no WHT)
Other deposits -
Corporate Debt Securities - (01.11.2002)

• Exemption (Section 9)
• Statutory income is the full amount falling due whether received or not -
No expenses.
• Final WHT.
• Notional credit for companies.
• Any assessment can be amended excluding unpaid and irrecoverable
amounts of interest.
• Interest not received and not recoverable on any loan can be excluded -
an additional assessment can be made when such interest is received.
• Interest from outside Sri Lanka. Net amount subject to DTR.

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Miscellaneous Sources of Income

1. Discounts - This is income received by discounting of bills etc.

2. Charges - These are receipts of money under a deed or court order

which is secured on the income or property of the payer.

3. Annuities - This should be a receipt of money which bears the following

characteristics.
• fixed sum receivable annually
• paid under legal obligation
• in the nature of income

4. Royalties - These are payments received as a consideration for the use

of any copyright, patents, trade marks, know how etc. by others.

5. Premiums - These are receipts in relation to any property which is over

and above the usual income. e.g.: key money.

6. Winnings from a lottery, betting or gambling - (w.e.f. 01.04.2004)

7. Donations/grants received by NGOO - (w.e.f. 01.04.2006)

8. Income from any other source - these may be any income which is not
falling within the specified sources of income. However, if such income is
of casual and non-recurring nature then such income should be
excluded.

There are no specific provisions in the I.R. Act with regard to the computation
of net income from the above sources. Therefore the computation of net
income should be done in keeping with the guidelines given below:
• Whether any expenditure has been incurred directly in producing such
income ?
• Whether such expenditure is of capital nature or revenue nature ?
• Whether such expenditure has been prohibited under the Inland
Revenue Act.

There are no exemptions applicable to the above mentioned sources.

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