Income taxes

Types of taxes
Company/corporate tax

→ Income tax
→ Taxable profits may also include taxable capital gains
→ Income tax is paid to the tax authority using a provisional tax payment system
→ The corporate income tax rate in south Africa
˗ 28%

Employee receiving a salary

→ Employee tax
→ Debit salaries
→ Credit salaries payable
→ Credit employee tax payable

Transaction tax

→ VAT
→ Three categories
˗ Vatable supplies
˗ Zero-rated supplies
˗ Exempt supplies
→ VAT vendors who sell vatable supplies must charge VAT
˗ Output VAT
→ VAT vendors who buy vatable supplies may claim back VAT
˗ Input VAT

Shareholder receiving the dividends

→ Dividend tax
→ Is levied at 20%
→ Is a tax on the shareholder
˗ But is paid by the entity on behalf of the shareholder and thus
˗ Does not form part of the entity’s tax expense

Many taxes

→ Other taxes
→ Governments often levy many other hidden taxes, such as
˗ Property rates
˗ Postage stamps
˗ Excise duty included in the petrol price
˗ Unemployment funds
˗ Many more
Recognition of income tax
Income tax expense is measured by multiplying these taxable profits (or the tax loss) by the tax
rate applied by the tax rate applied by the tax authorities

→ The income tax “follows” the element that gave rise to the tax
→ Income tax expense is recognised in a single line item on the Statement of Profit or Loss and
Other Comprehensive Income
˗ However, it needs to be separately disclosed for the ‘Profit or Loss’ and the ‘Other
Comprehensive Income’
˗ Present each item of ‘Other Comprehensive Income’ before tax and the tax separately

Income tax expense:

Income tax expense = taxable profits x tax rate

→ Principle: Current income tax is measured at the amount that is expected to be paid to or
recovered from the taxation authorities for the current period
→ To calculate income tax expense, we need two numbers:
˗ The taxable profits
˗ The relevant tax rates

Taxable profits vs Accounting profits

Accounting profit

→ Accounting profits are calculated in terms of IFRSs

→ Profit or loss for a period before deducting tax expense
→ Found on Statement of Profit or Loss and Other Comprehensive Income
→ Income earned less expenses incurred

Taxable profit

→ Determined in accordance with the local tax legislation

→ Profit or loss for a period
˗ Determined by tax law upon which income taxes are payable or recoverable
→ Only in the notes to the financial statements
→ Income that is taxable less expenses that are deductible

The applicable rate of income tax is never levied on the accounting profit (i.e. profit for the period,
before tax), but on it is applied to the taxable profit
Differences
Permanent

→ The accounting profit and taxable profit will differ and this difference will not reverse over
time
→ This difference will mean the effective rate of tax and the applicable rate will differ

→ Income earned that is exempt from tax

˗ Exempt income
→ Expenses that are incurred that will never be deductible for tax purposes
˗ Non-deductible expenses

Temporary

→ The accounting and tax treatments of something differ in a year

→ But over time there is essentially no difference between the two treatments

→ Income that is earned in a particular period that is taxable in another different period
→ Expenses that are incurred in a particular period that are deductible for tax purposes in
another different period

Tax rate
→ Tax is rate to use is:
˗ The enacted tax rate as at the reporting date
˗ Or if a new rate has been proposed, then using the new rate
 If it has been substantively enacted and effective by reporting date

Moving from accounting profits to taxable profits

→ Accounting profit
˗ i.e. net profit from SPLOCI
→ Plus/minus permanent differences
˗ Non-deductible, non-taxable and exempt
˗ Examples:
 Dividends received
 Fines and penalties
 Interest paid to SARS
 Donation expense
 Capital gain
 Etcetera
→ Plus/minus temporary differences
˗ Tax base vs carrying amount
˗ Examples:
 Depreciation vs wear and tear
 Profit vs recoupment
 Loss vs scrapping allowance
 Income received in advance
  Prepaid expenses
 Etcetera
→ Equals taxable profit

Formula – Income Tax Act

Gross income

Less : Exempt income (dividend received)

Income (sub-total)

Less : Allowable deductions (general and special)

Plus : Taxable capital gains (80% inclusion rate)

= Taxable income

Gross income
→ The total amount
˗ Only taxed on amounts that have determinable value (no notional amounts)
→ In cash or otherwise
˗ If in forms other than money = market value of item on date of acquisition
→ Received by or accrued to or in favour of such company
˗ Taxed on amounts received or receivable
˗ Amount is included on the earlier date of receipt and date of accrual
→ Excluding receipts/accruals of a capital nature
˗ These transactions may attract capital gains tax
˗ CGT is applicable to assets disposed of by a taxpayer after 01 October 2001
˗ Capital gain is included in taxable income at 80%
 Therefore 80% of the capital gain is taxable and 20% is exempt

Must meet all four criteria to be gross income

Key terms
→ Profit before tax
˗ Profit/loss as determined by IFRS
→ Taxable profit
˗ Profit as determined by Income Tax Act
→ Income tax
˗ Taxable profit x tax rate %
→ Year of assessment
˗ Individuals / entities: 28 February
˗ Companies / close corporations: Financial year end
Exempt and non-deductible
Exempt income is not taxable

→ Included in accounting profit

→ Subtract exempt income to get taxable profit

→ Although an amount is included in gross income, the act provides for certain income to be
exempt from tax
˗ All South African dividends received by or accrued to any company are exempt income

Non-deductible expenses can not be deducted for tax purposes

→ Already removed from accounting profit

→ Add non-deductible expenses to get taxable profit
˗ Expense must be reversed

→ Types of non-deductible expenses:

˗ Fines and penalties
˗ Donations without a certificate
˗ Personal expenses

Capital Gains Tax

→ In South Africa 80% of a company’s capital gain is taxable
˗ 40% of a human’s capital gains is taxable
→ What is a capital gain for capital gains tax?
˗ A capital gain arises when a capital asset is sold at a selling price (SP) that exceeds the
original cost price (CP) of an asset
˗ SP > CP
→ How are capital gains calculated?
˗ The capital gain (profit) is calculated as the difference between the selling price and
the original cost price of the capital asset
˗ CGT = SP – CP
→ Capital gains tax is not a separate tax
˗ Instead, it forms part of a taxpayer’s normal tax calculation

Accounting profit
→ Profit or loss on sale
˗ Proceeds on sale
˗ Less carrying amount
→ Capital profit on sale
˗ Proceeds on sale
˗ Less original cost

Taxable profit
→ Capital gain on sale
˗ Proceeds on sale
˗ Less base cost
→ Taxable capital gain
 ˗ Capital gain
˗ Multiplied by the inclusions rate for companies
 @ 80%
→ Refer to example three (slide 26)

Temporary differences
What are temporary differences?

→ Income or expense is included in the calculation of accounting profit in a different period to

the period in which it is included in the calculation of taxable profit
→ Therefore, if we compare the total accounting profit and the total taxable profit over a
longer time-period, the difference disappears

To convert accounting profits to taxable profits:

→ Undo or remove the accounting treatment of temporary differences and implement the tax
treatment

Accrual system differences

Income

→ Accrual system:
˗ Recognise income when it is earned
→ Tax system (hybrid system):
˗ Tax income on the earlier of the date of receipt (cash) or earning (accrual)

Receivables

→ Accrual system:
˗ Recognise income when it is earned even though cash was not yet received
→ Tax system (hybrid system):
˗ Recognise income when it is earned even though cash was not yet received
→ No temporary difference

Income received in advance

→ Accrual system:
˗ Only recognise as income when it is earned (until then it’s a liability)
→ Tax system (hybrid system)
˗ Recognise income when it is received
→ Temporary difference in timing
Expenses

→ Accrual system:
˗ Recognise expenses when they are incurred
→ Tax system (hybrid system)
˗ Deduction of an expense on the date it is incurred unless:
˗ It is a prepayment
 In which case the expense could be tax-deductible before it is incurred
˗ It is a provision
 In which case the expense could be tax-deductible only after it is incurred

Payables

→ Accrual system:
˗ Recognise expenses when it is incurred even though it was not yet paid
→ Tax system (hybrid system)
˗ Recognise expenses when it is incurred even though it was not yet paid
→ No temporary difference

Provisions

→ Accrual system:
˗ Incur an expense before we pay for it
→ Tax system (hybrid system):
˗ Non-deductible until paid
→ Temporary system in timing

Prepayments

→ Accrual system:
˗ Recognise expenses only when incurred even though it was paid earlier
→ Tax system (hybrid system):
˗ Recognise expenses when paid
→ Temporary difference in timing

Allowable deductions
General (s11(a) read s23)

→ Expenditure and losses,

→ Actually incurred or paid,
→ During the year of assessment,
→ In the production of income,
→ Not of a capital nature

→ General deduction formula

Special (s11(b) to s19)

→ Bad debts (credit losses)

→ Allowance for expected credit losses
→ Repairs
→ Wear and tear
→ Special wear and tear
˗ (manufacture)
→ Building allowance
˗ (industrial)

Special deductions

Bad debts (credit losses) (s11(i))

A deduction for bad debts is allowed in respect of amounts:

→ Which are due to the company;

→ Which during the year became bad;
→ Which have been included in the taxpayer’s income in current or previous year of assessment
All three conditions must be fulfilled in order for a debt to qualify for
deduction

Allowance for expected credit losses (doubtful debts) (s11(j))

→ IFRS 9 (financial instruments) used to calculate the allowance for expected credit losses
amount for accounting purposes
→ Remember this allowance is set-off against debtors control to measure the Trade and
receivables at the fair value
˗ i.e. the cash that is most likely going to be received in the future
→ Remember the allowance must be calculated annually and any movement goes to the Statement
of Profit or Loss and Other Comprehensive Income as either an expense or a gain
˗ Expense: increased allowance from previous year
˗ Gain: decreased allowance from previous year
→ A company is allowed to deduct, for tax purposes:
˗ 25% of the total amount of its list of doubtful debts – if allowance for expected credit
losses measured using “12 month expected credit losses” (IFRS 9) or,
˗ 40% of the total amount of its list of doubtful debts- if allowance for expected credit
losses measured using “lifetime expected credit losses” (IFRS 9)
→ This amount is deducted in the year in which the debts are considered doubtful and added
back the following year
→ For BAC 200 the deduction or percentage that should be used will be given

Wear and Tear (s11(e))

As mentioned under the general deduction formula, a taxpayer may not deduct capital expenditure in
calculating its taxable income, e.g. machinery, vehicles or furniture acquired.

Therefore, the Income Tax Act makes provision for a deduction called wear and tear which is similar
to depreciation for accounting purposes and which may be claimed by the taxpayer as a deduction.
Section 11(e) contains the provisions for the calculation of the wear and tear allowance. The wear and
tear allowance is proportionately reduced if the asset was acquired during the year.
Practice note 19 (issued SARS) provides the following information:

→ A list of write-off periods for assets

→ The allowance is calculated on cash price of the asset
→ Wear and tear is claimed on straight-line method
→ Asset is written off in year of acquisition if cost is less than R7 000

For BAC 200 the write-off period or percentage and that apportionment is applicable is given.

Special wear and tear allowance (s12C)

New or unused machinery or plant used by a taxpayer for the first time directly in a process of
manufacture (or similar process) the wear and tear allowances are calculated in terms of section 12C
and not in terms of section 11(e).

The allowance is 40% in the year in which the machinery or plant is first brought into use and 20% in
each of the subsequent three years.

The allowance / deduction is not apportioned on a time basis

For BAC 200 the percentage and the fact that it is not apportioned is given.

Temporary differences – depreciable assets

Depreciation

→ IFRS
→ Expensed (as depreciation or amortisation) at a rate that reflects the entity’s estimation of
the was the asset is expected to be used

Wear and tear

→ Income Tax Act

→ Cost to be deducted in the calculation of taxable profits
→ Using standard rates set out in the tax legislation

Carrying amount

→ IFRS
→ Amount that is presented on the face of financial statements that represent asset(s)
→ CA = Cost – Accumulated depreciation

Tax base

→ Income Tax Act

→ Carrying amount but calculated based on tax legislation
→ TB = Cost – Accumulated wear and tear

What does this all mean?

→ Depreciation will not equal wear and tear

→ When calculating taxable profit, we remove the affects of depreciation and add the effects
of wear and tear
 → Tax base and carry amounts are important when selling assets
→ Refer to example eight (slide 50)

Selling an asset – tax

In accounting when we sell an asset we calculate profit

Profit on sale = Selling price – Carrying amount

For tax we calculate two types of profit:

Capital gain:

→ Selling price (proceeds)

→ Original cost
→ Only 80% is included in taxable profits

Recoupment:

→ Original cost
→ Tax base
→ Entire amount is included in taxable profits

→ For tax purposes if an asset is sold below the original cost there is no capital gain
→ Capital gain + Recoupment will not equal accounting profit
→ Base cost = cost price

Recoupment and Scrapping Allowance

Recoupment
Can be compared to (non-capital) profit in accounting.

→ As the capital asset is used, so entity claims a wear and tear deduction (s11(e))
˗ Reduces taxable income
→ Recovery of previous tax deductions
˗ For tax purposes
→ Limited to the original cost of the asset
→ Only wear and tear previously allowed is recouped
→ Entire recoupment is included in taxable profit
˗ Only 80% of capital gains is included

Scrapping allowance
Can be compared to a loss of sale of asset in accounting

→ If asset is sold for less than its tax base:

˗ Income Tax Act allows for scrapping allowance similar but not necessarily equal to the
loss
˗ For accounting purposes
→ Does not mean no compensation received
→ Deducted in calculating taxable income
→ Not a capital loss
→ Refer to example nine (slide 57)
Assessed losses
→ When calculating taxable profit, a negative figure can be reached
˗ Entity has made a tax loss
˗ No current tax is payable for the year of assessment in which there is a tax loss
→ Accounting loss:
˗ Expenses > Income for a period
→ Tax loss:
˗ Allowable tax deductions > Gross income less exempt income
 Allowable tax deductions: Expenses and allowances
→ Assessed loss:
˗ Previous year’s taxable loss as confirmed by SARS
→ In the case of a company:
˗ Assessed loss from previous year can be set off against taxable income in the current
year
˗ Thereby, decreasing taxable income and decreasing tax expense for current year
→ Always be indication if assessed losses should be included in taxable profit calculation in BAC
200
Calculation of current income tax
(converting accounting profit into taxable profit)

Profit before tax xxx

Adjust for permanent differences

(less exempt income and add non-deductible expenses)

Less exempt dividend income (xxx)

Less exempt capital profit

- Less capital profit SP-CP (xxx)
+ Add taxable capital gain (SP-BC) x 80% xxx

Add non-deductible fines xxx

Add non-deductible donations xxx

Profit before tax (that the accountant knows will be taxable at some stage xxx

Adjust for movement in temporary differences

Add depreciation xxx

Less wear and tear (xxx)

Less non-capital profit on sale; or SP (limited to CP) - CA (xxx) or

Add loss on sale xxx

Add recoupment on sale; or SP (limited to CP) -TB xxx or

Less scrapping allowance on sale (xxx)

Add income received in advance (closing balance) xxx

Less income received in advanced (opening balance) (xxx)

Less expense prepaid (closing balance) (xxx)

Add expense prepaid (opening balance) xxx

Add provision (closing balance) xxx

Less provision (opening balance) (xxx)

Taxable profit or loss xxx

Income tax xxx

(28% of taxable profits)
Deferred taxation
→ At year end the carrying amount of an asset or liability must be compared with the tax base
of each asset or liability
˗ Carrying amount of asset or liability is calculated by applying IFRS
˗ Tax base is calculated by applying Income Tax Act
→ If the amounts differ then deferred tax asset or deferred tax liability arises
→ If deferred tax asset or liability at the end of the year differs from the opening balance
˗ Movement must be recorded
→ Movement in deferred tax asset or liability will be given in BAC 200
→ Refer to slide 83

Payment of income tax

→ Payment system requires two prepayments of tax during the year
˗ Called provisional tax payments
→ To make each of these payments the entity will have to estimate the year current income tax
˗ Halfway through the year
˗ And again at the end of the year
→ Half the estimated tax for the year is to be paid within the first 6 months of the year of
assessment
→ Balance of the estimated tax for the year is to be paid on or before the end of the last 6
months
→ Third estimate is then documented on an official form and submitted to the tax authorities
˗ Commonly referred to as a tax return
→ Tax assessment is prepared by SARS
˗ Indicates final amount of tax that should have been paid
˗ Adjustment will be made to current tax to ensure that it reflects final amount of tax

Process and relevant journal entries

Step one:
Record provisional tax payments (prepayments)

→ 1st provisional payment

˗ 6 months after commencement of tax year based on estimated taxable income
˗ 50% of total tax payable
nd
→ 2 provisional payment
˗ Towards end of reporting period based on estimated taxable income for the year
˗ Total payable less 1st payment

Current tax payable (SFP)

Bank (SFP)

Step two:
Calculate taxable income and tax expense
Step three:
Record tax expense and total current tax payable at year end

Income tax expense (P/L)

Current tax payable (SFP)

Step four:
Submit tax return (ITR 14) to SARS

Step five:
Receive tax assessment from SARS

Step six:
Calculate and record difference between financial statements and SARS

Under-provision:
Income tax expense (P/L)
Current tax payable (SFP)

Over-provision:
Current tax payable (SFP)
Income tax expense (P/L)

Step seven:
Record penalties and interest (if applicable)

Penalties (P/L)
Interest expense (P/L)
Current tax payable (SFP)

(included in other expenses – not income tax expense)

Step eight:
Record 3rd payment (final/top-up)(tax liability)

Current tax payable (SFP)

Bank (SFP)

OR

Record refund from SARS (tax asset)

Bank (SFP)
Current tax receivable (SFP)

Refer to example 11
Disclosure
Statement of financial position
Current tax receivable (e.g. a VAT refund expected) and current tax payable

Amounts owing for various types of taxes must be disclosed separately

Statement of comprehensive income

→ Tax expense line item on the face of the statement of comprehensive income
→ This line item should be presented in the profit or loss section of the statement of
comprehensive income and should be referenced to a supporting note
→ Remember, tax for OCI items will be disclosed per OCI item and it will be separate from
profit and loss tax

Rate reconciliation

→ Effective tax rate is simply calculated as the tax expense as a percentage of accounting
profit
→ Effective tax rate will differ from the applicable tax rate due to
˗ Permanent differences
˗ Under/over provisions
˗ Rate changes
→ Temporary differences will not cause the applicable tax rate and effective tax rate to differ
˗ Because of deferred tax adjustment