ADJUSTED PROFIT COMPUTATIONS

Objective: At the end of this topic, you should be able to:

 Explain the concept of adjusted profit, assessable profit, and total profit
 Distinguish between expenses that are allowable and disallowable for the purpose of
taxation
 Compute for adjusted profit, assessable profit, and total profit

Introduction
Businesses engaged in trading or other forms of commercial activities usually have an
objective of profit maximization. To determine the profit made, financial statements are
normally prepared in line with accounting principles and guidelines which may not agree
with the requirements for taxation. Therefore, the tax authorities will require adjustments
to the accounting profit as presented in the financial statement in order to arrive at a profit
that aligns with tax regulations. This profit is called the adjusted profit and serves as the
basis for further tax computations.

Concept of Adjusted Profit

This is the profit arrived at after adjusting/modifying for allowable and disallowable items
used in the computation of the accounting profit.

Allowable and Disallowable Expenses

The Company Income Tax Act 2004 (as amended) prescribes expenses that are either
allowable or disallowable for the purpose of tax. For any expense incurred by a business to
be allowable for the purpose of tax, the general rule is that such expense must be incurred
wholly, reasonably, exclusively, and necessarily (WREN) for the purpose of generating profit
chargeable to tax. This is what is referred to as the WREN rule.

Wholly - The entire amount in question must be incurred for earning business income;
Exclusively - The expense must be incurred only for the generation of the income;
Reasonably - The expense should be realistic when compared with the prior year’s expense,
income generated, industry standard, regulatory approval etc.; and
Necessarily - Income cannot be derived without incurring that particular expense.

Apart from the WREN rules, some sections of CITA 2004 (as amended) are worth
highlighting with respect to adjusted profit computation. Specifically, section 24 itemized
the following deductions as allowable expenses:

(a) Subject to the provision of the seventh schedule of this Act, any sum payable by way of
interest on any money borrowed and employed as capital in acquiring the profits subject to
30% of EBITDA (assessable profit before interest, tax, depreciation and amortization). For
the purpose of computing the EBITDA, such interest must be on a loan incurred wholly,

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reasonably, exclusively, and necessarily (WREN) for the purpose of generating profit
chargeable to tax;
(b) rent and premiums for the period incurred in respect of land or building occupied for the
purposes of acquiring profits. In the case of residential accommodation occupied by
employees of the company, the rent allowable is subject to a maximum of 100% of the basic
salary of the employees;
(c) expenses incurred during the year in respect of salary, wages, or other remuneration
paid to employees;
(d) cost to the company of any benefit or allowance provided for the senior staff and
executives which shall not exceed the limit of the amount prescribed by the collective
agreement between the company and the employees and approved by the Federal Ministry
of Employment, Labour and productivity and Productivity, Prices and Income Board, as the
case may be;
(e) expenses incurred for repairs of premises, plant, machinery, or fixtures employed in
acquiring profits;
(f) bad debts incurred in the course of a trade or business proved to have become bad
during the period for which the profits are being ascertained;
(g) any contribution to a pension, provident or other retirement benefits fund, society or
scheme approved by the Joint Tax Board under the powers conferred upon it by paragraph
(g) of section 85 of the Personal Income Tax Act and subject to the provisions of the Fourth
Schedule to the Act and to any conditions imposed by that Board; and any contribution
other than a penalty made under the provisions of any enactment establishing a national
provident fund or other retirement benefits scheme for employees in Nigeria;
(h) in the case of profits from a trade or business, any expense or part thereof:
* incurred during that period wholly, exclusively, necessarily and reasonably for the
purposes of such trade or business and which is not specifically referable to any other period
or periods, or
* incurred during any previous period wholly, exclusively, necessarily and reasonably for the
purpose of such trade or business and which is specifically referable to the period of which
the profits are being ascertained;
* Proved to the satisfaction of the Board to have been incurred by the company on research
and development for the period including the levy paid by it to the National Science and
Technology Fund which is not deductible under other provision of this section;
(i) Any other deduction as may be prescribed by the Minister by any rule;
(j) Dividend or mandatory distributions by a real estate investment company duly approved
by the Securities and Exchange Commission;
(k) Compensation payments which qualifies as interest under section 9(1) c of the Act, made
by a lender to an approved agent or borrower in a Regulated Securities Lending Transaction.

Section 25 and 25A of CITA also provide for deductions of donations made to approved fund,
body, or institutions in Nigeria for ascertaining the profits. Such donations should not be an

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expenditure of capital nature; it must be made out of profit; and must not exceed 10% of the
total profit ascertained before such deductions. Furthermore, for the purpose of
ascertaining the profit or loss of a company for the period from any sources chargeable for
tax, there shall be deduction for the amount of donation to educational institutions
(universities, research institutes etc). This particular donation can be of a revenue or capital
nature and must not be greater than an amount that is equal to 15% of total profit before
deduction of any allowance or 25% of the tax payable in the year of deduction, whichever is
higher.

The Finance Act 2020 further stipulates that donations made by companies in cash or kind to
any fund set up by the Federal Government or any State Government, or to any agency
designated by the Federal Government or to any similar Fund or purpose in consultation
with any Ministry, Department or Agency of the Federal Government, in respect of any
pandemic, natural disaster or other exigency shall be allowed as deductions as follows:

(a) the cost of in-kind donations made to the Government and any designated agency shall
be allowed as deductions; or

(b) where companies have either procured or manufactured items for contribution, the cost
of purchase, manufacture or supply of such in-kind contributions shall be allowed as
deductions provided that requisite documentation evidencing the donation and the cost
thereof are provided to the relevant tax authority and demonstrated to be wholly,
reasonably, exclusively and necessarily incurred in relation to the procurement, manufacture
or supply of the in-kind contributions.

It should be noted that the donations made to any government fund in respect of any
pandemic, natural disaster or other exigency shall be limited to 10% of assessable profits
after deduction of other allowable donations made by the company.

The list of approved Funds, Bodies and Institutions to which donations could be made under
the 5th Schedule is as follows:
1. The Boys Brigade of Nigeria
2. The Boys Scouts of Nigeria
3. The Christian Council of Nigeria
4. The Cocoa Research Institution of Nigeria
5. Any educational institution affiliated under any other educational institution recognized
by any Government in Nigeria
6. The Girl Guide of Nigeria
7. Any hospital owned by the Government of the Federation or of a State or any University
Teaching Hospital or any hospital which is carried on by a society or association otherwise
than for the purpose of profits or gains to the individual members of that society or
association
8. The Institute of Medical Laboratory Technology

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9. The National Commission of Rehabilitation
10. The National Library
11. The Nigerian Council for Medical Research
12. The National Science and Technology Development Agency
13. The Nigerian Institute for International Affairs
14. The Nigerian Institute for Oil Palm Research
15. The Nigerian Institute for Trypanosomiasis Research
16. The Nigerian Museum
17. The Nigerian Red Cross
18. A public fund established and maintained for providing money for the construction or
maintenance of a public memorial relating to the civil war in Nigeria which ended on 15th
January, 1970
19. A public institution or public fund (including the Armed Forces Comfort Fund) established
or maintained for the comfort, recreation or welfare of members of the Nigerian Army, Navy
or Air Force
20. A public fund established and maintained exclusively for providing money for the
acquisition, construction, maintenance or equipment of a building used or to be used as a
school or college by the Government of the Federation or a state or by a public authority or
by a society or association which is carried on otherwise than for the purpose of profit or
gain to the individual members of that society or association.
21. The National Youth Council of Nigeria
22. The National Sports Commission and its State Associations
23. The Nigerian Society for the Deaf and Dumb
24. The Nigerian Society for the Blind
25. The Nigerian National Advisory Council for the Blind
26. Associations or Societies for the Blind in Nigeria
27. Training Centres and Residential Schools for the Blind in Nigeria
28. The National Braille Library of Nigeria
29. The Nigerian Youth Trust
30. Van Leer Nigerian Education Trust
31. Southern Africa Relief Fund
32. Islamic Education Trust
33. The Institute of Chartered Accountants of Nigeria Building Fund
34. Any public fund established or approved by the Government of the Federation or
established by any of the state governments in aid of or for the relief of drought or any
other national disaster in any part of the Federation.

Section 26 of the Act permits a deduction for the purpose of research and development,
provided such a deduction does not exceed 10% of the profit ascertained before any
deductions. In addition, companies engaged in research and development for

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commercialization shall be granted 20% investment tax credit on their qualifying capital
expenditure for that purpose.

DEDUCTIONS NOT ALLOWED

Section 27 addresses the deductions not allowed in ascertaining a company's profits. The
section provides as follows:
Notwithstanding any other provision of this Act, no deduction shall be allowed for the
purpose of ascertaining the profits of any company in respect of-
(a) capital repaid or withdrawn and any expenditure of a capital nature;
(b) any sum recoverable under an insurance or contract of indemnity;
(c) taxes on income or profits levied in Nigeria or elsewhere, other than tax levied outside
Nigeria on profits which are also chargeable to tax in Nigeria where relief for the double
taxation of those profits may not be given under any other provision of this Act;
(d) any payment to a savings, widows and orphans, pension, provident or other retirement
benefit fund, society or scheme except as permitted by paragraph (g) of section 24 of this
Act;
(e) depreciation of any asset;
(f) any sum reserved out of profits, except as permitted by paragraph (f) of section 24 or 25
of this Act or as may be estimated to the satisfaction of the Board, pending the
determination of the amount, to represent the amount of any expense deductible under the
provisions of that section, the liability for which was irrevocably incurred during the period
for which the income is being ascertained;
(g) any expense of any description incurred within or outside Nigeria involving related
parties as defined by the Transfer Pricing Regulation, except if such is consistent with the
regulation;
(h) any expense incurred in deriving tax exempt income, capital losses and expenses
allowable as deduction under CGT Act;
(i) compensation payments which qualifies as interest or dividend under section 9(1) c of the
Act, made by a borrower to an approved agent or lender in a Regulated Securities Lending
Transaction;
(j) penalty or fine imposed in pursuant to a legislation made by the National or State House
of Assembly;
(k) any tax or penalty borne by a company on behalf of another person.

Although certain items of expenditure are specifically listed as allowable or disallowable as

seen above, it is important to point out that this list is not exhaustive. Thus, some expenses
incurred in the course of running a business might not be among these ones listed.
Therefore, the extent to which such expenses would be allowed or disallowed for tax
purposes would depend on factors such as existing income tax practices and decided law
cases. Let us examine some of these items of expenditure:

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1. Legal Expenses: Legal expenses or costs are usually incurred in respect of a wide range of
undertakings. While some may be allowable for tax purposes, others may not. The following
legal expenses or costs are usually allowable for tax purposes:
(a) expenses incurred on debt collection or recovery;
(b) expenses incurred in renewing short-term leases. Short-term leases are leases with
duration of less than fifty years;
(c) expenses incurred in rating valuation appeals;
(d) expenses incurred (including compensation) in getting rid of an irresponsible or difficult
employee or director. Such expenses are made to preserve rather than improve the
reputation of the business;
(e) expenses incurred in defending the title of business to any of its assets or the
maintenance of existing trade rights;
(f) expenses incurred in preparing staff service agreements; and
(g) expenses incurred in the successful defense of a traffic offence charge.

The following legal expenses or costs are usually disallowable for tax purposes:
(a) expenses incurred in challenging income tax assessments, whether or not the tax payer
wins the dispute;
(b) expenses incurred in respect of the acquisition of a new fixed asset;
(c) expenses incurred in respect of a lease taken out for the first time;
(d) expenses incurred in the renewal of long-term leases; and
(e) expenses incurred on issue of share capital.

2. Penal Liabilities: Penal liabilities such as fines for traffic offences or tax penalties on
employees are usually disallowable, since they do not constitute trade or business expenses.

3. Entertainment Expenses: Entertainment expenses are allowable when they are

customary, vouched and are wholly, exclusively, necessarily and reasonable for purposes of
entertaining clients or customers. They serve as inducements to clients and customers alike
to patronize the business and increase its taxable income. Expenses incurred during festive
periods such as Christmas are also allowable, provided they are reasonable. What would be
regarded as ‘reasonable’ under the circumstances is usually worked out with the tax
authorities.

4. Travelling Expenses: Travelling expenses incurred in moving back and forth from one’s
residence to his place of work is disallowable. Such expenses are not undertaken in the
course of the performance of the trade or business. However, travelling expenses incurred
in the course of performing one’s job are allowable.

5. Misappropriations: Funds misappropriated by subordinate employees are allowable

expenses provided they are not recoverable under an insurance policy. Funds
misappropriated by senior staff are however not allowable as business expenses.
Defalcations or pilferages of goods by employees are also allowable expenses, provided

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they are not recovered under an insurance policy. However, where such defalcations or
pilferages are carried out by senior staff or a director, they would not qualify as allowable
expenses.

6. Subscriptions or trade associations, funds, and societies: Generally, subscriptions may be

allowed or disallowed depending on their nature and the purposes to which they are
applied. Subscriptions paid to trade associations are normally allowable expenses.
Membership of such associations bestows specific advantages on the trade or business.
Such expenses are therefore regarded as necessary. Subscriptions paid to a Political Party
Fund are normally disallowable expenses, unless they can be proved to be of a great
advantage to the trade or business. Subscriptions paid to societies such as social clubs,
cultural groups and sports clubs etc. are normally disallowable expenses.

Waivers or refund of liability or expenses

When a deduction has been allowed to a company under the provisions of section 24 or 25
of the CITA Act in respect of any liability or expense incurred by the company and such is
now waived or released or refunded in whole or part, then such amount that is waived,
released or refunded shall be deemed to be profits of the company on the day such waiver,
release or refund was made.

In summary, the format below is a simple way to arrive at the adjusted profit.

Net profit as per account xxx

Add:
Disallowed expenses included xxx
Taxable income omitted xxx
xxx
Deduct:
Allowable expenses not yet deducted (xxx)
Nontaxable income included (xxx)
Adjusted profit xxxx

Due to the introduction of the Finance Acts (FA), the following are to be noted regarding
expenses.

Any expense incurred income exempted from tax (Nontaxable income), losses of a capital
nature and any expense allowable as a deduction under the CGT Act is a disallowable expense
for the purpose of CIT.

Small companies are exempted from paying CIT and TET. A small company is one with a
turnover less than twenty-five million Naira (N25m).

Tertiary Education Tax (TET) is now computed at 3% of assessable profit.

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CIT rate is now graduated and shall apply in the following manner: a) 30% for large companies
(with N100m and above in turnover), b) 20% for medium companies (with turnover between
N25m and N100m), c) Nil for small companies.

Information Technology Tax (IT) is tax deductible for CIT purpose. This tax is 1% of profit before
tax and payable by Mobile service providers and all telecommunications companies, Cyber
companies and internet providers, Pension managers and pension related companies, Banks
and other financial institutions, and Insurance companies.

National Agency for Science and Engineering Infrastructure (NASENI) levy is tax deductible for
CIT purpose. It levied at 0.25% of the profits before tax of companies in the banking, mobile
communication, ICT, aviation, maritime, and oil and gas sectors, that generate annual turnover
of more than ₦100m.

Nigeria Police Trust Fund (NPTF) levy is tax deductible for CIT purpose. It is levied at 0.005% of
net profit of all companies operating in Nigeria.

The Finance Act 2020 has further increased the list of approved bodies by additional 6 items.
See the fifth schedule for the comprehensive list.

The donation to educational institution or public fund established or approved by the

Government of the Federation or established by any of the state governments in aid of or for
the relief of drought or any other national disaster in any part of the Federation could be of a
revenue or capital nature

Assessable Profit
After arriving at the adjusted profit, the next thing is to determine what part of it will be
assessed to tax. To do this, balancing charge is added to the adjusted profit while loss relief
is deducted. Furthermore, the profit is aligned with the relevant basis period (preceding
basis period).The format below is a simple way to arrive at the assessable profit.

Adjusted profit xxx

Add Balancing charge xxx
Less Loss relief (xxx)
Assessable profit xxx

Total Profit
After arriving at the assessable profit, the next thing is to determine what part of it will be
charged to tax at the prevailing rate. To do this, capital allowance and any other relief is
deducted. The format below is a simple way to arrive at the assessable profit.

Assessable profit xxx

Less Capital allowance (xxx)
Total profit xxx

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Basis of Assessment of Tax Payable
There are different bases of assessments. We have the normal basis (when the accounting
period is twelve months) and ‘abnormal’ basis (when the accounting year is less than twelve
months usually as a result of commencement, cessation, or change in accounting date of a
business). Depending on the circumstances of a company, the tax authority may apply some
rules to determine the tax payable by a company. These include

Minimum tax rule: Minimum tax is the least amount of tax a company is expected to pay in a
given year, it is computed as 0.5% of gross turnover less Franked Investment Income. Gross
turnover means the gross inflow of economic benefits during the period arising in the
course of the operating activities of an entity. This also includes sales of goods, supply of
services, receipt of interest, rent, royalties or dividends. A company without taxable profit or
has a tax payable that is less than the minimum tax computed is required to pay minimum
tax. However, a company will be exempted from minimum tax if it satisfies any of the
following:

• It is within its first four calendar years of business.

• It has annual gross turnover of less than N25 million in the relevant year of assessment.

• It carries on primary agricultural trade or business.

Dividend rule: Where a company has no tax payable and distributes dividends in excess of its
taxable profits, such dividends will be taxed at the applicable tax rate. This is what is called
excess dividend tax (EDT). Dividends paid out of already taxed retained earnings, dividends
from profit exempted from CIT, franked investment dividend, and dividend distributed by
Real Estate Investment Companies from rental and dividend income earned are not subject
to EDT.

Turnover/Deemed profit rule: where it appears that the true amount of a company’s
assessable profits cannot be reasonably ascertained. The tax authority may apply this rule. In
practice, the tax authority applies a 20% deemed profit on every income, and taxes the profit
at 30%, resulting in an effective tax of 6% on turnover. This practice is mostly adopted for
Non-Resident Companies (NRCs), and on rare occasions for Nigerian companies.

Commencement and cessation rules: To avoid the issues associated with overlapping and
gaps in basis period, the CITA was amended as regards how companies that are starting
operation or ending their operations are to be assessed to tax.

Rule for commencement

Section 29(3)(a) of CITA provides that, for the first year, the assessable profits shall be the
profits from the date in which the company or business commenced operations to the end
of the first accounting period. As such, assessment shall not be on the actual year basis but

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on preceding year basis. That is profits of the first accounting period are assessed to tax in
the year of assessment immediately following the year in which business commenced.

Section 29(3)(b) of CITA stipulates that for the second year, the assessable profits shall be
the profits from the first day after the first accounting period to the end of the second
accounting period.

Section 29(3)(c) of CITA provides that for the third year and for each subsequent year, the
assessable profits shall be the profits from the day after the accounting period just ended.

Rule for cessation

Section 29(4) of CITA as amended provides that where a company permanently ceases to
carry on a trade or business (or in the case of a company other than a Nigerian company,
permanently ceases to carry on a trade or business in Nigeria) in an accounting period, its
assessable profits therefrom shall be the amount of the profits from the beginning of the
accounting period to the date of cessation and the tax thereof shall be payable within six
months from the date of cessation.

In summary, two years are important. For the year of cessation (Ultimate year), assessable
profits therefrom shall be the amount of the profits from the beginning of the accounting
period to the date of cessation. For the penultimate year, assessable profits shall be on
preceding year basis. There is the possibility of filing tax returns of two years assessment in
the year of cessation. Where this occurs, the company or individual must file the outstanding
tax returns in addition to those arising upon cessation of business.

Practice Questions
1. The profit of Van Gaal Enterprises for the year ended 31st December, 2014 was as
follows:
N N
Gross profit from trading 500,000
Profit from sales of motor vehicle 6,000
506,000
Salaries and wages 120,000
Trade subscription 5,000
Legal expenses 4,500
Depreciation 60,000
Rent and rates 15,000
Provision for doubtful debts 3,500
Repairs and maintenance 60,000
Postages and stationery 6,000
(274,000)
Net Profit 232,000

 Provision for doubtful debt contains N2,200 being a general provision

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  Repairs and maintenance include a cost for erecting a new gate to the business
premises. The amount is N16,750
Required: Compute the adjusted profit for the year ended 31st December 2014.

2. XYZ Enterprise has been trading for several years. The Detailed Profit or Loss Account
of the business for the year ended 31st December 2018, is as shown below:
N N
Gross Profit 50,000,000
Profit on sales of vehicle 1,200,000
51,200,000
Less: Expenses
General administration 3,000,000
Staff salaries 12,219,500
Stationery and printing 800,000
Postage and telephone 400,000
Electricity 700,000
Entertainment 250,500
Vehicle repairs and maintenance 455,000
Bank charges 800,000
Donations 4,500,000
Periodical and technical journals 80,000
Audit and accountancy fee 2,500,000
Defalcation and embezzlement 1,200,000
Repairs and renewals 85,000
Depreciation 5,010,000
Tax Offense Penalty 2,800,000
Bad and doubtful debts – Specific 200,000 (35,000,000)
Net Profit 16,200,000

You are provided with the following additional information:

(i) Expenses of N360,000 of a capital nature was included in staff salary.
(ii) Donations were to a local charity. None of the employees benefitted from it.
(iii) One third of vehicle repairs and maintenance related to private use.
(iv) Further examination of accounts revealed that salary of N800,000 was paid to an
unknown person.
(v) The Chief Accountant perpetrated 75% of the defalcation.
(vi) Allowable expenses of N230,000 have been omitted from the accounts
(vii) Repairs and renewals comprised of:
N
Partitioning of new office 30,500
Repairs of plant and machinery 25,000
Repairs of office roof 29,500
85,000
(viii) Agreed capital allowance on qualifying capital expenditure was N7,500,000.

Required: Compute the Chargeable profit of XYZ Enterprise for the relevant tax year.

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3. A company or enterprise commenced business on 1st July, 2020 and makes up its
account to 30th September in 2020 and subsequent years. Identify the YOA and basis period
for the first three years.

4. XYZ Nigeria Limited makes up its account to 31st December and permanently ceased
operation on 30th April, 2020. What are the relevant years of assessment and the due date
for payment of tax due?

5. XYZ Nigeria Limited is a subsidiary of XYZ (UK) Limited. The assessable profit extracted
from the financial statement of the Nigerian company for 2020 year of assessment is
N400,000. In arriving at the assessable profits, the following amounts of interest had been
deducted: Interest on debts: Paid to XYZ UK Limited-N400,000; Paid to other creditors-
N200,000 N100,000 out of the amount paid to third parties was in respect of loan obtained
in generating tax-exempt profits.
Required: Calculate the amount of interest deductible in 2020 YOA

6. Roy Nigeria Limited reported a net profit of N6,700,000 for the year ended 31st
December, 2021. This is after charging the following expenses:
Depreciation…………………………………………………………… 500,000
Repairs to a section of its factory affected by fire.…………………. 200,000
Donations made during the year:
(a) Federal Government COVID-19 Relief Fund……………….…. 3,000,000
(b) The Boys Scout of Nigeria……………………………………. 500,000
(c) National Sports Commission………………………………… 2,000,000
(d) XYZ Political Party …………………………………………….. 300,000
(e) Auditorium building to University of Abuja…………………..10,000,000
Additional Information:
i. The factory building affected by fire is insured with XYZ insurance
ii. Unrelieved loss brought forward is N1,200,000
iii. Capital allowance for the year is N1,000,000

Required: Compute for the relevant year of assessment:

(a) The maximum allowable donations to non-government established fund
(b) The maximum allowable donations to government established fund
(c) The tax payable by the company

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