Certified Practising Accountants Papua New Guinea

Established under the Accountants Act 1996

Taxation Law and Practice

CERTIFIED PRACTISING ACCOUNTANTS PAPUA NEW GUINEA

P O BOX 1937
PORT MORESBY
NATIONAL CAPITAL DISTRICT
PHONE: 321 2105
FACSIMILE: 320 0469
EMAIL: cpapng@cpapng.org.pg
WEBSITE: www.cpapng.org.pg

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1. INTRODUCTION TO INCOME TAX

Learning Objectives

After you have successfully completed the work in this unit you should be able to:

• Explain the basic nature of income tax.

• Understand the background to income tax law in Papua New Guinea by reference to the
Income Tax Act 1959 as amended and other laws.

• Define and explain basic terms used in income tax law.

• Calculate taxable income by reference to the equation:

Taxable income = Assessable income less allowable deductions.

What is Income Tax?

Income tax is a tax on the income of individuals, companies and other legal bodies which we
shall cover in this course. Do not make the mistake of thinking that income tax refers only to
the taxation of a person’s salary or wage. Income tax differs from indirect tax which is, in
most cases, a tax on expenditure.

The main purpose of taxation is to raise revenue to finance government expenditure. There
are other economic and social objectives. For example, the government may use fiscal policy,
by lowering or raising taxes, in order to stimulate or reduce economic activity. The
government may create tax incentives to encourage certain activity. For example, tax
concessions (e.g., reduced tax or even no tax) may be offered to exporting firms, employment-
creating firms or to foreign investors. Tax incentives may be offered to firms in remote rural
areas to help develop such areas and to reduce rural-urban drift, as part of social policy. Taxes
may also be levied on certain goods, such as drink and tobacco, with the declared aim of
reducing their consumption. That such taxes rarely achieve a reduction in the consumption
of such goods is seldom of great concern to governments which confirms the fact that the
prime aim of levying taxes is to raise money.

Income tax is a direct tax in that it is directly borne by the taxpayer who actually ‘bears the
burden’ of the tax. This is in contrast to indirect taxes, such as goods and service tax (GST),
customs duties (import taxes) and excise taxes. In the case of these taxes, the taxpayer (e.g.
store owner or importer) may pass on all or part of the tax to the consumer, for whom the tax
is therefore an ‘indirect tax’.

Income tax paid by individuals is normally ‘progressive’ in nature. This means that a person
receiving a higher income pays not only a greater total amount of income tax, but more
proportionally, or in percentage terms, as well. The reason for this is on the grounds of
‘equity’ or fairness. In taxation theory, the ‘marginal utility’ or extra satisfaction gained from
obtaining more income decreases as one’s income rises. A person on a high income will not
gain much additional ‘utility’ from further income increases. It follows that to lose some of
that top income will not result in much hardship. For example, the loss of ‘utility’ or
satisfaction in paying K250 tax per fortnight may be no worse than a lower income earner
paying K50 per fortnight.

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You should bear this in mind when examining the vastly different amounts of tax payable by
high- and lower-income earners in the fortnight tax tables for wages and salaries produced by
the IRC.

Income Tax Law

Income tax law is a product of income tax legislation and case law (court decisions). The
Papua New Guinea Income Tax Act was passed in 1959 when income tax was introduced to
the country. The Act was based on Australian income tax. Since 1959, it has been amended
many times. It may be referred to as the Income Tax Act 1959 as amended.

In addition to the Income Tax Act, tax legislation also includes the following:

• Income Tax Regulations, which prescribe how certain parts of the Income Tax Act, and
other acts, are to be implemented. They are a form of delegated legislation, which allow
certain amendments to be made concerning the implementation of income tax without
requiring new laws to be passed.
• Income Tax Rates Acts of which there are currently eight separate Acts that specify the
appropriate rates of tax to be paid by the various categories of taxpayers.
• Stamp Duties Act and Regulation, which covers the imposition and collection of stamp
duties and administration of the Act.
• International Tax Agreements Act, which when read in conjunction with the Income
Tax Act, covers the numerous bilateral taxation agreements made between Papua New
Guinea and other countries for the collection of tax on transnational income.
• Goods and Services Tax (GST) which contains all provisions governing this tax.

In addition, the IRC publishes the schedule of depreciation rates for tax purposes.

Papua New Guinea income tax legislation is issued in book form. The version of income tax
law most widely used, by business firms and the IRC staff, is that issued by a commercial
publisher, CCH Australia Ltd. The Goods and Services Act is produced in a separate binder
booklet (which now also contains the Stamp Duty Act). CCH continually updates the law for
subscribers to this service.

(In this course, when reference is made to the ‘Act’ or ‘Income Tax Act’, or to certain sections
of the Act, we are referring to the Income Tax Act 1959 as amended.)

Interpretation of tax legislation

The basic rule is that tax legislation should be precise and should state clearly the intention
for imposing the tax so that the legislation can be strictly interpreted. The tax legislation is
not, however always precise. Our tax system is not a simple one with few transactions.
However, it is less complex than in more developed countries. The legislation is sometimes
ambiguous and difficult to interpret.

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As already stated, in Papua New Guinea there are two sources of taxation law
• Legislation (or statute law)
• Case law (or common law)

There are a number of steps that can assist in interpreting the legislation. First, we need to
examine the relevant statutory provisions of the legislation to determine the payments or
transactions which will be assessable and those that will be exempted or deductible; secondly,
to clarify situations where there is statutory ambiguity or uncertainty it is necessary to refer to
case law to interpret the legislative provisions. The courts have powers, under s155 of the
Constitution to interpret legislation in a way which would promote its purpose. In units which
follow we shall examine some case law in detail.

Language and terms used in Income Tax Law

It is important to apply the correct meaning of words used in income tax law. The rules for
applying the correct meaning of words are, the meaning of a word as applied in normal usage
should be used except where it differs from a general or specific definition in the Act. Section
4 of the Income Tax Act contains general definitions of terms used throughout the Act. There
are also specific definitions in other individual divisions of the Act. Section 4 definitions
should apply unless there is a different specific definition. In other words, specific definitions
override general definitions and general definitions override the everyday usage of the word.
It is important that you know at the outset the meaning of certain key terms in order to know
how tax payable is calculated. In the following two units we shall consider in greater detail
the meaning, in a tax context, of these and other terms.

Assessable Income

This is income that is taxable before any deductions are made. In other words, gross income.
The following receipts, for example, are classified as assessable income:
• salary or wages
• interest
• dividends
• gross income from a business
• partnership income
• rent
• commissions
• bonuses

Allowable Deductions (Sections 66-68)

These are amounts which are allowed to be deducted from assessable income in order to arrive
at a figure which represents taxable income.
As a general rule, actual payment need not be made in order to claim deduction, so long as a
liability is “incurred”. Allowable deductions include most expenditure which would normally
appear in the profit and loss accounts of a business (Section 68). Allowable deductions would
include:
• purchase of trading stock

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• manufacturing, trading and administrative expenses
• interest, rentals and royalties paid
Interest includes interest on funds borrowed for the purpose of producing assessable income,
this would include funds borrowed for the purpose of acquiring income producing assets
(including property plant and equipment and shares) or used in the conduct of business
activities. The Income Tax Act contains provisions governing the allowance of tax deductions
for general costs or outgoings incurred in deriving income or carrying on a business for that
purpose (Section 68). Excluded are expenses of a capital, private or domestic nature. These
provisions will be considered in detail in later units.

Taxable Income
This is actual income subject to tax after allowable deductions have been subtracted. It is
calculated by subtracting allowable deductions from assessable income. Taxable income is
quite often different to ‘accounting income’ due to different treatment on certain items
between the Income Tax Act and generally accepted accounting principles.

Derived Income

Income must normally be derived (or earned) to be subjected to tax. Income need not be
actually received to be derived. It is derived even though it is not actually paid over, when it
is reinvested, accumulated, or capitalised or otherwise dealt with on a taxpayer’s behalf or as
he directs. For example, if a taxpayer has a fixed deposit in his bank for K2,000 is income
whether the taxpayer withdrew it or not (Section 13).

In the accounting records of a trader, income is earned when the transaction is complete,
regardless of whether payment is received. The accrual method of accounting is generally the
required basis for the disclosure of assessable income. Accrued income is income earned
which has not yet been received. However, the earnings basis of assessment is not compulsory
for professional people, such as medical practitioners or accountants who are sole
practitioners.
Where money is received in advance, it is not actually assessable for tax until it has actually
been earned.

Exempt Income
This is income which is not included in a taxpayer’s assessable income. However, it must be
disclosed in a tax return. Exempt income includes:
• education allowances, scholarships, etc
• export sales of certain ‘qualifying goods’, i.e. which qualify for tax exemption
• certain government pensions
• income of religious institutions, hospitals and charitable bodies.
Payments made from exempt income may, however, be taxable (S.44). It should be noted
that income from illegal sources is also included as income for tax purposes.

Tax Rebates and Credits

A tax rebate is a tall allowance which is deducted from a person’s tax liability in order to
arrive at his final (net) tax liability. It is an amount `which is deducted from tax payable to

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arrive at the net tax payable figure. A tax credit, like a rebate, is a deduction from tax payable.
Tax credits are given for taxes already paid or payable. The amount of a rebate or credit can
never exceed the tax otherwise payable in some cases credits may give rise to a refund.

Non-Allowable Deductions:
Capital expenditure: expenditure of a capital nature (e.g. extension to premises, or purchase
of machinery) even though incurred in the course of producing assessable income, is not
deductible under the Income Tax Act. However, depreciation is allowable on assets used in
the production of assessable income.

Losses and outgoings ‘not incurred: certain expenditure, e.g. provisions made in the
company’s accounts for expected future liabilities, or bad debts, are not allowable as a
deduction for tax purposes. When such future liabilities are discharged, and payment is made,
or a bad debt written off in the case of a provision for bad debts, a tax deduction is allowed.

Losses and outgoings of a private or domestic nature: expenditure on the day to day
necessities of life is not allowable for tax purposes. Thus, items such as purchases of food,
medical expenses, life insurance are not allowable deductions. This may also include
expenditure to earn income, e.g. expenditure incurred in travelling to work, or childminding
to enable a mother to earn income is a private or domestic expense. It should be noted this
restriction would not generally apply to companies as such expenditure would not be private
or domestic from the company’s perspective. However, the payment of private expenses of
employees may give rise to a taxable benefit for the employee. Expenses incurred in changing
jobs, clothing expenses, wages paid to domestic servants, etc are also not allowable
deductions. Similarly, expenses or losses incurred in deriving exempt income are not
deductible.

Allowable Deductions

It is not necessary that the purpose of expenditure be the production of assessable income.
But it should be necessarily incurred in carrying on a business. The Income Tax Act looks at
the scope of the operations and activity and requires that the expenditure or loss in question
was relevant or connected to the production of assessable income. Thus, a deduction will be
allowed for business takings lost through robbery on the way to the bank, or certain legal costs
and advertising expenses incurred refuting allegations of dishonest business practices. The
robbery example illustrates an ‘indirect’ expense but one that exists as a connected and
relevant part of conducting a daily business undertaking.

Expenditure is also allowed as a deduction in the particular year it was incurred, although it
may not produce income until a future year.

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Evident of Expenditure

Before a deduction is allowable, a liability for the actual expenditure must have been incurred.
That is, the amount must have been paid, or the taxpayer is under a legal obligation to pay the
amount. There must be proof, and it is only allowable in the tax year in which it occurred.
Therefore, proper records or proof are very important. There is a tendency for some
accountants and taxpayers to expect the IRC to accept the amounts of deductible expenditures
without proper documentation. However, a taxpayer must produce supporting documents if
asked to do so. The ‘onus of proof’ is on the shoulders of the taxpayer. The Income Tax Act
(Section 364) requires business records to be kept for seven years. It is permissible to keep
such records electronically.

Papua New Guinea Resident and Non-Resident

The distinction between a Papua New Guinea resident and a non-resident is important for tax
purposes because residents are taxed on their worldwide income, whereas non-residents are
taxed only on their Papua New Guinea sourced income. In addition, non-residents are taxed
at different rates. Residence for income tax purposes has a particular meaning, different from
residence for citizenship purposes. Basically, an individual is resident for tax purposes if the
person has lived (or intends to live) permanently, or who has lived for a considerable time (or
intends to) in this country.

Normally, a person who has lived for at least 6 months (more than 183 days) can claim, for
tax purposes, to be a resident, of the country (Section 4(1)).

A resident company is one that has been incorporated in Papua New Guinea, or one which,
though not incorporated here, carries on business here and has either its central management
and control here or the majority of the shareholders who control the company are resident
here.

In the following unit we shall consider residence in greater detail.

Taxation Clearance for Money Remitted Overseas

Amounts of money exceeding K200,000 can be remitted overseas provided a tax clearance
certificate has been obtained, certifying that no taxes are outstanding and all tax requirements
to date have been met. This may be obtained from the IRC.

Following the two rounds of liberalisation of exchange control in June 2005 and September
2007, there are fewer circumstances in which it is required for persons or companies to obtain
Bank of Papua New Guinea authority to remit funds outside the country.

Capital and Income

If a receipt is of a capital nature it will not, under normal circumstances be taxable, because it
is not a receipt of income. Receipts from capital, normally referred to as ‘capital gains’ are
taxable in many countries, including Australia, and the introduction of capital gains tax in
Papua New Guinea is always a possibility.

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The distinction between income and capital is obviously important because income receipts
are taxable, but capital gains are not. Examples of capital gains are:

• sale of private property (unless purchased with the intention of resale at a profit),

• sale of private car (unless purchased with the intention of resale at a profit),

• sale of shares (unless purchased with the intention of resale at a profit).

Other gains, sometimes known as ‘windfall gains’ are similar to capital gains because they
are not treated as income and therefore are not taxable. Examples include:

• lottery win
• betting win by punter
• gifts from one person to another

Receipts of income normally have an element of ‘periodicity, recurrence and regularity’, i.e.,
normally recur on a regular basis, and are as a result of one’s work, business or investment.
Capital gains are usually a once only receipt because of some entitlement. A worker’s wage
is clearly income and therefore assessable for income tax. Any surplus or profit the same
person makes on the sale of a house is of a capital nature and therefore not assessable (taxable).
But what if the person buys and sells a house every year? There are two guidelines for
deciding whether a receipt is income or capital:

1. What was the intention of the taxpayer?

2. How often did he conduct the same transaction?

If the capital, in this case a house, was bought for resale (i.e. to make a profit), then the
proceeds would be assessable for income tax. A once and for all sale of capital would
normally not be assessable, but if repeated might be assessable.

A betting win by a punter would normally not be taxable. But if the punter was a professional
punter, i.e. was fully occupied in studying racehorses, and derived all his income from betting,
then money from a betting win would be taxable. Similarly, a gift is normally not taxable.
But tips to waiters or taxi drivers are taxable because they are considered part of such persons’
income in return for service rendered. Waiters, for example, often receive very low wages in
some countries, because it is expected they will receive much of their income as tips from
customers.

In the following unit we shall consider the distinction between capital and income, with the
assistance of case law, in greater detail.

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Financial Year

The financial year, or ‘year of income’ for tax purposes runs from 1 January to 31 December
(Section 4(1)). The Income Tax Act does allow the Commissioner General of Internal
Revenue, at his discretion, to allow an alternative year in limited circumstances (Section 12A).
Permission may be given to a company whose overseas parent company has a different year
end. For example, an Australian subsidiary company may be allowed to use the Australian
financial year from July 1 to June 30.

Reporting Currency (Section 14)

The currency used in tax returns should be kind. However, permission may be sought to use
a different reporting currency. For example, most tax returns submitted by petroleum
production companies and some mining companies operating in Papua New Guinea are in US
dollars. The accounts of these companies are in most cases in US dollars because most of the
income earned and expenditure incurred by these companies is in US dollars.

Internal Revenue Commission (IRC)

The IRC is responsible for administering the income tax system, as well as indirect taxes –
goods and services tax, and customs and excise taxes. The Commissioner General
(Commissioner) heads the IRC. Previously the Papua New Guinea Taxation Office was
responsible for income tax, and the Bureau of Customs and Excise was responsible for indirect
tax. There are office branches of the IRC in all major towns. But, with the exception of Lae,
they deal only with GST, and customs and excise tax. The main office is situated in Port
Moresby in Champion Parade, and its address is:

Internal Revenue Commission

PO Box 777, Port Moresby
Telephone Number: 322 6600
Fax Number: 321 4249

The Income Tax Act lays down that officers of the IRC must not reveal information submitted
by taxpayers in their tax returns (Section 9). Also, they must not assist taxpayers to prepare
their tax returns [Section 10(2)].

How Taxable Income is Determined

A Papua New Guinea resident’s taxable income is calculated as follows:

Gross income from all sources

Less: exempt income (if any) = Assessable income
Less allowable deductions = Taxable income

Tax payable will depend on the tax rate applied, less tax rebates or credits, if any.

Gross income includes all types of income, such as income from employment, from running
a business and /or from other sources.

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Example
Kina
Gross income 20,000
Exempt income 2,000
Allowable deductions 10,000
Tax rebate 50
Rate of tax (for companies) 30%

Calculation of taxable income and tax payable:

Kina
Gross income 20,000
Less: exempt income 2,000
Assessable income 18,000
Less: allowable deductions 10,000
Taxable income 8,000

Tax payable - 8,000 x 30% 2,400

Less: tax rebate 50
Net tax payable: 2,350

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Self-Assessment Exercises

Question 1

What is the difference between “assessable income” and “taxable income”?

Question 2

Indicate in each case whether or not the following items should be considered as assessable
income in PNG:

a) tips received by waiters and taxi drivers

b) proceeds from the sale of a house. The house was purchased to live in but was sold one
year later because the owner stated it was unsuitable.

c) a lump sum workers compensation payout given to an employee for the loss of eyesight
as a result of an industrial accident.

d) lump sum superannuation payout of K10,000 to contributor.

e) workers compensation payments over ten fortnights to worker while recovering from
industrial accident.
f) interest due annually on a fixed deposit with a Papua New Guinea bank and which is, at
the request of the taxpayer, added to the principal outstanding.

g) lump sum representing three months’ salary in lieu of (instead of) notice received by an
employee who has been dismissed.

h) an amount received from an insurance company under a ‘loss of profits’ policy.

i) rental income received on Gold Coast property by a (i) resident (ii) non-resident
taxpayer.

Question 3

In each case state whether or not the following expenses would be treated as allowable
deductions:

a) customs duty paid on goods imported which will later be sold.

b) you are employed in Port Moresby, but you pay K500 to fly to Madang each weekend
where your family and permanent home is situated.

c) you spend K2,000 repairing the roof of a house which you are renting out to tenants

d) you pay for meters to be installed in a fleet of taxis which you are operating for hire.

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Question 4

Gross income K20,000

Exempt income 3,000
Allowable deductions 14,000

Calculate:

a) Assessable income
b) Taxable income

Question 5

Assessable income K36,000

Dependants rebates 1,030
Allowable deductions 2,000
Assuming the tax rate is 30%, calculate tax payable.

Question 6

Allowable deductions K4,500

Exempt income 2,000
Gross income 10,000
Tax rebate 150
Tax rate 25%

Calculate:

a) Assessable income
b) Taxable income
c) Net tax payable

Question 7

Allowable deductions K2,000

Exempt income 200
Tax rebate 450
Gross income 8,000
Tax rate 30%

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Calculate:

a) Taxable income
b) Net tax payable.

Question 8

Gross wages
K18,700
Tax paid 3,700
Interest received 340
Dividends from shares 170
Betting winnings 620
Money from sale of family home 93,000
Allowable deductions 3,500
Exempt income 400

Calculate assessable income.

Question 9

Government pension (exempt) K2,000

Laki ticket win 3,500
Wage 8,000
Sales revenue 20,000
Loss of takings in robbery 3,500
Depreciation of equipment 1,000
Purchase of vehicle 6,000
Net purchase of trading stock 7,000

Calculate:

a) Gross income
b) Exempt income
c) Assessable income
d) Allowable deductions
e) Taxable income

Question 10

Wages
K4,000
Dividends 100
Sale of house 6,000
Sales revenue 10,000
Cost of trading stock 5,000
Purchase of machinery 4,500
Calculate:
a) Assessable income
b) Allowable deductions
c) Taxable income

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Answers: Self-Assessment Exercises

Question 1

Assessable income is any income that is subject to tax. Taxable income is the net amount of
income to be taxed. That is, assessable income less allowable deductions.

Question 2

a. Assessable income b. Not taxable

c. Not taxable d. Assessable income (part of it)
e. Assessable income f. Assessable income
g. Assessable income h. Assessable income
i. Assessable income j. (i) Assessable income; (ii) Not taxable.

Question 3

(a) Allowable deduction

(b) Not allowable
(c) Allowable
(d) Not allowable (capital expense)

Question 4

(a) A. Assessable income: 17,000

(b) B. Taxable income: 3,000

Question 5

Tax payable: 9,170

Question 6

(a) A. Assessable income 8,000

(b) B. Taxable income 3,500
(c) C. Net tax payable 725

Question 7

(a) A. Taxable income 5,800

(b) B. Net tax payable. 1,290

Question 8

Assessable income 19,210 (wages, interest, dividends)

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Question 9

(a) A. Gross income 30,000 (Laki ticket capital gain – not income)
(b) B. Exempt income 2,000
(c) C. Assessable income 28,000
(d) D. Allowable deductions 11,500 (vehicle capital purchase)
(e) E. Taxable income 16,500

Question 10

(a) A. Assessable income 14,100

(b) B. Allowable deductions 5,000
(c) C. Taxable income 9,100

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2 ASSESSABLE INCOME

Learning Objectives

After you have successfully completed the work in this unit you should be able to:

• Explain what assessable income is according to the Income Tax Act.

• Distinguish between income, capital and windfall gains for tax purposes.

• Explain the relevance of the following with reference to assessable income:

o residence
o source of income
o derivation of income
o exempt income

• Apply relevant case law to assist in determining what is assessable income.

In the opening unit, you learnt what was assessable income in simple terms and how it was
computed. In this unit we shall consider in greater detail the nature of income and what makes
it assessable for tax purposes in Papua New Guinea. Income is not a term that is defined
comprehensively in the Income Tax Act. So, it is necessary to discuss the concept (or idea)
of income and the key factors that determine income for tax purposes. These factors include
– whatever receipts are of an income or capital nature; the taxpayer’s residence and source of
income; whether or not the income has been derived; and whether the income has been granted
exempt status. It is necessary to refer to a number of important court cases to assist in
determining what is assessable income.

General Assessing Provision

The Income Tax Act contains a general provision that assesses “income” and various specific
provisions that deem certain types of receipts to be included in the assessable income of a
taxpayer.

According to (Section 46(l)), the assessable income of a taxpayer shall include:

a) Where the taxpayer is a resident – the gross income derived directly or indirectly from
all sources whether in or out of Papua New Guinea; and

b) Where the taxpayer is a non-resident – the gross income derived directly or indirectly
from all sources in Papua New Guinea,

but shall not include exempt income.

There has been a multitude of tax cases developed over the years seeking to define ‘income’
for the purposes of this assessing provision.

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The key question to be determined is, therefore.

1. Is the receipt income?

Once this has been established, other key elements which must be considered to
determine the assessability of a receipt are:

2. Residence of the taxpayer

3. Source of the income
4. Derivation of the income
5. Has the income been attributed exempt status?

Is the Receipt Income or Capital?

Taxation law dictates that gains be distinguished between income or capital. The
income/capital distinction can be so borderline in some instances it may not be at all clear as
to which way the issue may be decided.

Notwithstanding this, some factors have been developed over the years through case law
which assist in making the distinction between income and capital. It should be borne in
mind, however, that none of these factors are necessarily conclusive on their own.

These factors are summarised as follows:

(i) The “once and for all” test [Villambrosa Rubber v Farmer (1910) 4 TC 4291]

An amount received once and for all is more likely to be in relation to capital than income
which is generally periodic or repetitive. One must consider the frequency and regularity of
receipts or gains to see if they form part of the income flow of the recipient under ordinary
concepts or are a normal incident of that income producing business or activity or arise
directly out of it in the ordinary course of carrying on that business.

(ii) “Enduring benefit” test [British Insulated & Helsby Cables Ltd v Atherton (1926)
ACS205]

An amount which results in the termination of some enduring benefit such as the disposal of
a capital asset, is likely to be capital whereas a receipt which arises from the disposal of
circulating assets, such as trading stock, is likely to be of a revenue character.

“Business entity” test [Sun and Associated Newspapers v FCT (1938) 61 CLR 337]

An amount which arises from the reduction or disposal of all or part of the profit-making
apparatus, organisation, substance or structure is likely to be of a capital nature whereas those
receipts flowing from the operations would be of an income character.

Some case references have been included at the end of this unit for those students interested
in further understanding the concepts of income.

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In FCT v. D.P. Smith 81 ATC 4114, the taxpayer received disability insurance payments in
respect of the period of his incapacity to work. It was held that the sums received were income
and his premiums paid in respect of the policy were deductible. It was held that compensation
payments of this kind were a substitute for income and therefore took the place of a revenue
receipt.

As mentioned above, no one test is conclusive on its own in determining the character of a
particular receipt as can be seen below in Myer’s case. It is well established that receipts
received regularly in the ordinary course of business are considered income and a one-off type
receipt is likely to be capital in nature, but the Myer case shows that this is not always the
case.

Hence the question – Can profit from an isolated transaction be assessable income?

In VCT v. Myer Emporium Ltd, it was held that a once only receipt may be income even if it
is not the primary business activity of the taxpayer. The taxpayer, the parent company in a
group which carried on business in retail trade and property development lent $80 million to
a subsidiary. The subsidiary was to repay the loan over several years at a fixed interest rate.
The loan agreement provided that the principal amount and interest payable could be sold,
assigned or transferred. The parent sold the rights to principal and interest to a bank for
approximately $45 million. It was held that the one-off payment constituted a receipt of
income, even though it arose from an isolated transaction. All that occurred in principle was
that a lump sum was received in exchange for a future interest income stream.

Certain rules of income (and capital) at common law have been developed and the
following six points provide a summary:

1. All gains at common law may be divided into three categories, income, capital or
windfall gains. Windfall gains are unearned and do not relate to revenue earning
activity, business or occupations, and in Papua New Guinea are not taxable. They would
include such things as lottery prizes and “mere” gifts, which are not taxable in Papua
New Guinea. Gains from hobbies and gambling are usually classified in this neutral
group along with windfall gain.

2. Capital and income are exclusive categories, although it is possible to convert one into
the other. For example, selling the right to an annuity. The annuity payments are
income at common law. The right to those payments, however, is the capital or source,
and realising it gives rise to capital, not to income.

3. Since income is a dynamic concept “that which comes in”, it is normally necessary that
there be either an actual receipt, or at least an existing profit or gain (which must also
be actually “derived”), before it can constitute “income”.

Moreover, the income flow must come from outside the taxpayer, or group of taxpayers,
involved. “Mutual income”, that is the funds generated amongst themselves by
members of a group, club, or society, for their own exclusive and mutual benefit, is not
“income” in the strict sense. The doctrine of mutuality is founded on the notion that one
cannot profit from dealing with oneself.

4. Income at common law is manifested in receipt of money, or something which is

equivalent to money, or can be converted into money.

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5. The common law approach to revenue derived from a “source” means that any receipts
which come from or are directly related to the occupation, profit-making process or
business of the taxpayer will be treated as income in the common law sense.

6. The concept of income as a regular flow over a period means that amounts which are
received regularly or as a normal incident of an occupation, will ordinarily be treated as
income.

Flows divorced from the source of income producing activity, or an occupation, would
not be income, e.g. time payments for the sale of a capital asset.

Flows connected to a normal incident of the business or field of activity would be

income; Rolls Royce v Jeffrey (IT) (1962) 40 TC 443. Myer Emporium Ltd v FCT
(1987) 87 ATC 4363 may suggest that a once only receipt may be income even if not
part of the primary business activity if the transaction was intimately related to the
ordinary business activities and carried out with a purpose of profit. This particular
decision has widened the concept of income under Section 46(l).

Residence

There is an express definition of ‘residence’ for each type of entity incorporated in the Income
Tax Act.

Individuals

The residence of an individual is relevant not only to the individual’s personal tax liability but
may also be significant in determining the residence of other entities in which the individual
has a controlling interest (i.e. companies, trusts, superannuation funds).

“a resident of Papua New Guinea” is defined in Section 4(l) of the Income Tax Act to mean a
person other than a company who resides in Papua New Guinea and also includes a person –

a) Whose domicile is in Papua New Guinea, unless the Commissioner General is satisfied
that the person has a permanent place of abode outside Papua New Guinea.

b) Who has actually been in Papua New Guinea, continuously or intermittently, during
more than one-half of the year of income, unless the Commissioner General is satisfied
that the person’s usual place of abode is outside of Papua New Guinea and that the
person does not intend to take up residence in Papua New Guinea; or

c) Who is a contributor to a prescribed superannuation fund or who is the spouse or a child

under 16 years of age of such a person?

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The question of residence involves a question of fact to be determined in each case. No single
factor is necessarily decisive, and many are inter-related. The weight given to each factor
varies depending on the circumstances. The following are some of the factors to be considered
in determining where a person resides:

• physical presence in a country during a year of income.

• nationality.
• history of residence and movements.
• mode of life i.e., social and living arrangements.
• if the person is a visitor to a country, the frequency, duration and purpose of visits.
• intention or purpose of presence in Papua New Guinea
• if the person is outside the country for part of the year, the purpose of absences.
• the family and business or employment ties which the person has with the
particular country.
• whether a place of abode is maintained by the person in the relevant country or is
available for his use whilst he is there; and
• maintenance and location of assets.

The word “abode” means a person’s residence – where he/she lives with his/her family and
sleeps at night.

The word “permanent” has been held to be used in a sense in contrast to temporary and
transitory, but it does not mean everlasting. Refer to Applegate’s case in the tax case section.

Companies

A company is resident in Papua New Guinea if it is:

(a) Incorporated in Papua New Guinea; or

(b) If not incorporated in Papua New Guinea, carries on business in Papua New Guinea and
has either its central management and control in Papua New Guinea or its voting
power controlled by Papua New Guinea resident shareholders: [Section 4(l)].

Incorporation

If a company is incorporated in Papua New Guinea, it will be treated as a resident company

in Papua New Guinea.

Central Management and Control

If a company carries on business in Papua New Guinea and has its central management and
control in Papua New Guinea, it will be treated as a resident of Papua New Guinea.

For those who are interested in reading some authoritative case law concerning this point,
refer to Malayan Shipping contained in the tax case section.

Central management and control are, generally speaking, the place where the directors of the
company meet to conduct and make policies and decisions on the operations of the company
(Koitaki Para Rubber Estates Ltd v FCT (1940) 2 AITR 136).

Control of Voting Power

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Finally, a company will also be treated as a resident of Papua New Guinea if the company
carries on business in Papua New Guinea and has its voting power controlled by Papua New
Guinea resident shareholders.

The presence of controlling shareholders who are residents in Papua New Guinea creates a
link between the residence for companies based on the residence principles established for
individuals if those individuals are capable of controlling the company through their
respective voting rights.

Dual Residency and Double Tax Agreements

For those countries with which Papua New Guinea has entered into a Double Tax Agreement,
residency status can be determined by that Agreement in circumstances where an individual
or company is considered to be a resident under the domestic legislation of each country.

This is achieved by a series of “tie breaker” tests contained in the Double Tax Agreement
which will ultimately allocate residence between one country or the other.

Source of the Income

Source is the concept used to determine where income is derived and is generally determined
as a question of fact.

Residents: taxed on income derived from all sources whether in or out of Papua New
Guinea

Non-Residents: taxed on income derived from Papua New Guinea sources only. Income
derived outside Papua New Guinea is exempt income (Section 36)

Factors determining the source of remuneration of services rendered.

The factors to be taken into account include:

• the place where the services which give rise to the income are performed (most
importantly).
• the place where the relevant service contract is made; and
• the place where the amount is payable.

Personal Services – Likewise for an individual deriving wages, salary or professional fees –
the place where duties or services are performed usually determines the source.

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Trading Profits - For a trader, whose business consists largely of making contracts and
performance is unimportant, the place where contracts are made often determines the source.
Conversely where the performance of a contract is important and the making of the contract
has little importance, the place where the contract is performed will be of most significance.

Dividend Income – The source of dividend income is generally the place where the fund of
profits out of which the dividend is paid is located.

Interest Income – The source of interest income is generally the place where the obligation
to pay the interest arises, i.e. where the loan agreement is made or where credit was given.

Rental Income – Rental property income is sources where the property is situated.

Again, source is a concept which generally lies in the domain of the common law.

There are, however, a number of instances where the source of a particular type of income is
deemed to be in Papua New Guinea or income is taxed in PNG even though the source may
be outside PNG, for example:

• royalties (Section 4C)

• mortgage interest (Section 46(1))
• businesses carried partly in and partly out of PNG (Sections 60 - 65)
• overseas shipping (Division 14)
• overseas contractors (Division 14A)
• management fee withholding tax (Division 14C)
• agreements and determination of sources of certain income (Division 15)
• non-resident interest (Section 186 (2))

Case law

In Nathan v FCT (1918) the Australian High Court found that the question of source is not a
question of law but one of fact.

In Spotless Services Ltd v FCT (1995) the process involved examining various factors such as
the place where the loans in question were advanced, borrowers’ residence and the legal rights
of the involved parties as per the loan contract.

In FCT v French (1957), the Australian High Court found that wages paid to a taxpayer were
derived from sources in New Zealand. In this case the taxpayer was employed by an
Australian company and paid in Australia for work performed in New Zealand for about three
weeks of each year. The court found that wages income must usually be found to have its
source where the employment is performed.

In FCT v Mitcham (1965) the Australian High Court found that income earned by an actor,
who was paid by a Swiss company to act in two motion pictures, was not derived from sources
in Australia. The actor was required to work in Australia for 11 weeks. The salary was paid
to the taxpayer in the United States. The court stated that there was no rule of law to be
derived from Franch’s case, which requires that income will be sources where the work is
performed.

Derivation of Income

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The Income Tax Act does not define when income is derived, therefore, case law principles
will apply.

There are two fundamental methods in determining when income is derived; they are known
as the “Cash “and “Actuals” methods.

Cash Method

Under the cash basis, income is generally considered to be derived when it is received.

Generally, non-trading income (i.e. salaries, wages, dividends, interest, rent) is brought to
account for tax purposes on a cash basis.

Sometimes it will be appropriate for business income to be returned on a cash basis. For
example, where business receipts represent in substance a reward for professional skill and
personal work, and business expenditure contributes only a subsidiary or minor degree, then
the cash (receipts) basis may be appropriate.

Accruals Method

Under the accrual method, income is derived when the taxpayer’s right to receive it becomes
a legally enforceable debt (i.e. the income has been earned).

As a general rule, trading income (i.e. income arising from trading activities of a business
carried on by the taxpayer) is brought to account for tax purposes on an accrual basis. The
presence of any of the following factors to a significant degree indicate that the accruals
method is more appropriate:

a) the taxpayer’s income producing activities involve the sale of trading stock.

b) the outgoings incurred by the taxpayer, in the day to day conduct of the business, have
a direct relationship to income derived.

c) the taxpayer relies on circulating capital or consumables to produce income; or

d) the taxpayer relies on staff or equipment to produce income.

Monies Received Prior To Being Earned:

There may be instances where a trading enterprise may receive cash from its business
activities but, those monies are not yet earned.

Arthur Murray (NSW) Limited v F.C.T. (1965) 114 C.L.R 314 is a good example of this
situation.

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Arthur Murray Dance Studio received amounts in advance for dancing lessons which were
held not to be income derived until the lessons were actually given. This principle is used
extensively in the airline industry where a ticket may be paid for many weeks in advance of
travel but the airline operator does not recognise the income for tax purposes until the
passenger has actually travelled using that ticket.

Money Credited or Reinvested Prior to Being Received (Section 13)

Income shall be deemed to have been derived by a person although it is not actually paid over
to him but is reinvested, accumulated, capitalised, carried to any reserve, sinking fund or
insurance fund, however designated, or otherwise dealt with on his behalf or as he directs.

Exempt Income

There are provisions in the Income Tax Act which deem specific types of income to be exempt
from income tax. Items that are expressly excluded from assessable income are, for the most
part, contained within Section 19 to Section 43A of the Income Tax Act. There are also a
number of specific tax incentives in the form of exemptions from tax (s.45A to s.46BD).

Exemption of Charitable Bodies (Section 25A)

The income of an approved charitable body or institution is exempt from income tax however
the provision in the principal act has been amended to include a definition of “charitable
purpose” and provides guidelines for approval including that 80% of the income should be
used for charitable purposes. The granted exemption applies for a period of 5 years, where
after further exemptions may be granted for up to 5 years, upon reapplication.

Exemption of Certain Non-Profit Bodies (Section 27)

The income of a society, association or club that is not carried on for the purposes of profit or
gain to its individual members is normally exempt from income tax. The provision convers
most social clubs which operate within the country.

The ‘principle of mutuality’ recognises that a taxpayer’s income consists only of money
derived from external sources. Thus, profits made by a club from its members is not income
and therefore not taxable. However, income earned by a club from non-members is assessable
income.

Exempt Interest

Under s.35(2) certain interest income is exempt:

• interest income derived by any person from a foreign currency deposit (approved by
Bank of Papua New Guinea) with a Papua New Guinea financial institution.

• interest income derived by a non-resident lender from a company engaged in petroleum,

mining operations or gas operations within Papua New Guinea.

Interest income derived by any person from a long-term bond issued on or after 16 November
2004 is no longer exempt income. Interest income derived from a long-term bond issued prior
to that date remains exempt. A ‘long term’ bond is a fixed interest security issued by the

Page | 24
Government or a resident company or society with a maturity date of at least five years after
issue.

Specific Assessing Provisions

These provisions have been included for many reasons, some of which are inserted to achieve
fiscal objectives of the government and others have been inserted to clarify any uncertainty
that may exist concerning the assessability of a particular item under the general assessing
provisions.

These specific provisions include the following:

Profit Making Undertakings [Section 47(I)(c)]

Profit arising from the sale of any property acquired for the purpose of profit making by sale
or carrying on or carrying out a profit-making undertaking or scheme is included in assessable
income. For example, if you purchased shares or property with the intention of later selling
these assets at a profit, any profit realised is assessable income.

Allowances, Gratuities, Compensations etc [Section 47 (I)(c]

Allowances, gratuities, compensation, bonuses and premiums allowed, given or granted

which relate directly or indirectly to employment or services rendered are treated as assessable
income.

Other Specific Assessing Provisions:

Section
46B lump sum payments made in consequence of retirement or termination from
employment
47(I)(b) Income (stream) derived from a will etc
47(I)(f) royalties
47(I)(g) subsidies received in or in relation to carrying on a business
47(I)(h) loan procurement fees; commissions or fees for procuring a loan of money
47(I)(i) life assurance bonuses
47(I)(j) insurance receipts in respect of trading loss or indemnity for loss of trading stock,
profits or income
47(I)(k) exchange gains – realised exchange gains derived from debts incurred on or after
11 November 1986
47A premium for lease
48 dividends
49 annuities
50 insurance recoveries for loss of livestock and trees
51 excess of trading stock on hand at the end of the year over the value of trading
stock at the beginning of the year
65E salaries, wages and allowances
78(2) excess consideration overwritten down value of depreciable property
85(3) bad debts recovered

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Taxation of Interest

Interest payments from financial institutions and companies received by individuals (and
companies) are taxable. In addition, a withholding tax of 15% is payable, so interest is
received net of this amount. This tax is an interim tax only. All agreements with Papua New
Guinea (see Unit 8). The tax withheld on the interest paid to a non-resident recipient is the
final tax on this income.

Example

A taxpayer received K680 interest from a Bank. This was K800 less 15% interest withholding
tax paid. The taxpayer also earned business income of K50,000. Tax payable would be:

Tax on K50,800 15,000

Less credit for interest withholding tax paid 120
Net tax payable 14,880

Tax Cases: Assessable Income

Principles of Income

Henry Ones (IXL) Ltd v FCT

The distinction between capital and income was again drawn out in this case, where a lump
sum was received upon the assignment of a right to receive royalties in respect of various
trademarks which had been licensed by the assignor.

Held: The Full Federal Court held that, except in the case of an assignment of an annuity
where the income arises from the very contract assigned, an assignment of income from
property without an assignment of the underlying property right will be on revenue account
no matter what it’s form.

Principles of Residence

FCT v Applegate (1979) 9 ATR 899; 79 ATC 4307

On 8 November 1971 the taxpayer, an associate partner of a Sydney law firm, and his wife
left for Vila, New Hebrides, to establish and manage a branch office for the firm. The couple
had given up the tenancy of the flat in which they had lived and in fact left no assets in
Australia. On arrival in Vila, they took up a twelve-month lease of a house with an option of
renewal for further twelve months. The taxpayer was admitted as a legal practitioner in the
New Hebrides and they were granted a residency permit for a period of one year. The permit
was subsequently renewed for a further two years. Although it was always intended by the
taxpayer (and his employer) that he would return to Australia, no definite date for his return
had been set, and it was expected that his period away would be of a substantial length.

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The Commissioner included the taxpayer’s assessment of income tax for the year ended 30
June 1972, the income received by the taxpayer in the New Hebrides. The taxpayer’s
objection on the ground that it was income from a non-Australian source and that he was not
a resident of Australia, was rejected by the Board of Review, but subsequently upheld by the
Supreme Court of New South Wales. The Commissioner appealed.

Held: The appeal was dismissed, the court being of the view that although the taxpayer was
domiciled in Australia, from 8 November 1971 until 30 June 1972, his permanent place of
abode was outside Australia. In the context of para (a)(i) of the definition of ‘resident’ in s6(I)
of the Assessment Act, a taxpayer’s permanent place of abode will be outside Australia if, in
the year of income, he did not reside in Australia but had formed the intention to, and in fact
did, reside outside Australia.

Mr Applegate subsequently resided in Port Moresby for a number of years.

Malayan Shipping Co Ltd v FCT (1946) 71 CLR 156;3 AITR 258; 8 ATD 75

Sleigh, an Australian resident who operated from Melbourne, held all but two of the 2500
issued shares of the taxpayer, a company incorporated in Singapore. The company’s
registered office was in Singapore, as were the homes of the other two directors, both
nominees of Sleigh. The articles of association of the company gave Sleigh total control over
the management of the company. This included the right to contract with the company and
to decide whether or not the company would accept any offer he made to it. During the
relevant period, the only business done by the company was to charter a vessel in London and
then to enter various sub-charters of the vessel to Sleigh. The charter party was executed in
London and signed on the company’s behalf by shipping agents acting under Sleigh’s
instruction. The documentation for the sub-charters was prepared and executed by Sleigh in
Melbourne and then sent to Singapore for execution on behalf of the company. The company
contended that, in the circumstances, it was not resident of Australia and in addition, any
income it received was derived from sources outside Australia.

Held: The taxpayer company was a resident of Australia. The central management and
control of the company was situated in Australia and thus at least some part of the business
was carried on there. The source of the company’s profits which arose from the sub-charters
was also in Australia because all the relevant decisions made in respect to the sub-charters
were made by Sleigh in Melbourne. The forwarding of the charter and sub-charters to
Singapore for acceptance by the company was a mere formality.

Principles of the Derivation of Income

Arthur Murray (NSW) LTD v FCT (1965) 114 CLR 314; 9AITR 673; 14 ATD 98

The taxpayer company carried on the business of dance tuition. Several courses of instruction
were offered and often the fee for the course was paid in full before the first lesson. In fact,
pre-payment was encouraged by offering a discount on the fee otherwise payable for the
course. Although the contact entered into provided that refunds were not available should a
student choose not to take all the lessons, refunds were often given. When the taxpayer
company received the fees in advance, they were immediately credited to an “unearned
Deposits – Untaught Lessons Account”. As the lessons were given, a corresponding amount
was transferred from that account to a revenue account. The company prepared its income
tax returns on the basis that the fees received in advance did not become part of its assessable
income until the lessons were given.

Page | 27
The Commissioner, on the other hand, issued assessments on the basis that the fees so received
were assessable income of the taxpayer at the moment of receipt. A majority of the Board of
Review upheld the Commissioner’s view and the company appealed.

Held: The fees paid in advance did not become part of the taxpayer’s assessable income until
the lessons were given. According to ordinary business concepts, a pre-payment under a
contract for future services does not by itself constitute a derivation of assessable income,
particularly where there is a possibility that the payment, or a proportion thereof, may have to
be returned if the services are not supplied. Furthermore, those concepts required that to be
‘income’, a receipt must be earned.

Henderson v VCT (1970) 119 CLR 612; 1 ATR 596; 70 ATC 4016

The taxpayer was one of 19 partners in a large Western Australian accounting practice. For
many years the income of the partnership was returned and assessed on a cash receipts basis.
However, during the year ended 30 June 1965, the partnership changed to the accrual method
of tax accounting. A consequence of this change was that a sum of $179,530, being fees
earned for work done during the year ended 30 June 1964 but not actually received until the
following year, was not recorded as income derived in any year of income. This is because
that sum was not actually received in the earlier year (when the cash basis was used). The
Commissioner refused to accept the change and assessed the partnership as if it had continued
to use the cash receipts method of tax accounting. The Commissioner’s action in this regard
was considered by the Full High Court.

Held:

(I) In the circumstances, the accruals methods of tax accounting were appropriate. The
partnership was such a large operation that what it earned in any one year was the true
measure of its income in that year.

(2) The earnings of the partnership comprised the fees it had received for the work done in
that year and any fees for work done in that year which were recoverable debts; it did
not include an allowance for work in progress.

(3) The Scheme of annual taxation does not allow for combining the results in more than
one year in order to obtain the assessable income for a particular year.

Page | 28
Self-Assessment Exercises: Residence

Question 1

B Jones, “BJ” to his friends, was a bank manager who was transferred by his employer to Fiji
for two yours. During that time, he and his family leased a house in Fiji. The family’s house
in Port Moresby was let, unfinished. The family furniture was stored in a neighbour’s double
garage.

At the end of the two-year period BJ had expected to move to his employer’s London breach.
Instead, to take advantage of promotion, he returned to Papua New Guinea. BJ was unaware
of the possibility of the PNG promotion until two weeks before his return to PNG.

• Discuss whether, for the two-year period, BJ would be regarded as a “resident” of Papua
New Guinea. For simplicity, assume that he left for Fiji two years ago and returned on
30 December during the current year of income.

Question 2

▪ Discuss whether the following come within the meaning of “resident” as defined in
Section 4 of the Income Tax Act:

a) John Brown aged 16 years, who was born in Papua New Guinea, has been living
for the past eight years with his uncle in Mexico. His mother died when he was
four years old and his Papua New Guinea resident father has been in a mental
hospital since John was eight years old.

b) Alan Peach has lived in Lae for the past four months and works as a rigger on a
large building project. One completion of the project Peach will return to Wales,
his native country.

c) Bill Smith, a Papua New Guinea citizen, has been living for the past two years in
Hong Kong where he owns his home. He has no family ties in Papua New Guinea
and does not intend to return to Papua New Guinea in the foreseeable future.

d) Jeff Wayne, an American film star, lived at a hotel in Madang during a visit to
Papua New Guinea (from 28 January to 28 November), the purpose of which was
to film a television series set by Papua New Guinea. The series was not a success
and Wayne returned to the USA on 28 November.

e) IMB Greatest, an American recording artist, arrives in Papua New Guinea on 1

June during the current year of income for her first Papua New Guinea tour.
Shortly after arrival she declares that she loves Papua New Guinea and intends to
buy a ranch and settle here permanently.

Would it affect your answer if you were told that Greatest intends to marry a Papua
New Guinean resident she has just met?

f) A company, incorporated in the USA, sends a management team to Papua New

Guinea to operate a local branch.

Page | 29
g) A company, incorporated in New Zealand, opens a branch in Rabaul to conduct
geological surveys in East New Britain for overseas clients.

h) A company incorporated in Papua New Guinea as the wholly owned subsidiary of

a company incorporated in Canada. No business will be carried on by the Papua
New Guinean company in Canada in the year of income.

i) A company incorporated in the New Hebrides to carry out merchandising activities

in the New Hebrides, which has its central management and control in Port
Moresby. Its voting power is controlled by Papua New Guinea residents.

Page | 30
Suggested Answers to Self-Assessment Exercises: Residence

Question 1

The facts in this case are similar to those in FCT v Applegate (1979) 9 ATR 899 in which it
was decided that the taxpayer was not a resident of Australia. It is important to recognise that
decisions as to residence have to be made with respect to each year of income. A taxpayer’s
intentions and events which happen after the end of the year of income are relevant factors to
be considered. However, they are no more than that.

It was also recognised in Applegate’s case that the expression “permanent place of abode”
alongside the word “domicile”. Permanent means something less than everlasting, otherwise
domicile of choice would change and two separate criteria would be unnecessary.

In deciding whether the taxpayer has a permanent place of abode, look to see what keeps a
taxpayer at a particular place. For instance, does the taxpayer have permanent employment?

BJ’s decision to abandon his residence in Papua New Guinea is a relevant consideration.

Weighing up the factors, BJ’s intended period of absence, employment in Fiji, being
accompanied by his family, inability to easily return due to his house being let, and unexpected
nature of his return, point to him being a non-resident in both years.

Question 2

In determining residence, a number of facts need to be determined, including:

• the taxpayer’s intention.

• the continuity and duration of the taxpayer’s association with a place; and
• whether the taxpayer is in the country for a temporary visit or expects to dwell there
permanently.

In many of the cases in this question definite answers cannot be given without making further
assumptions. Before addressing these cases, students should read carefully the definition of
“resident” in Section 6 and the decisions in FCT v Applegate (1979) 9 ATR 899 and Malayan
Shipping C Ltd v FC (1946) 3 AITR 258.

a) Brown is probably a resident in Mexico and not Papua New Guinea. Note that the
domicile of a person who is under a legal disability is the place of residence of the person
on whom he or she is dependent.

b) Whether Peach is resident may depend on where Peach was living before Lae; he may
have lived elsewhere in Papua New Guinea. If he did, he may be a resident by virtue of
the fact that he has lived in Papua New Guinea, during the year of income, for more than
183 days (provided the Commissioner is satisfied his usual place of abode is not outside
Papua New Guinea). If this is not the case, the short nature of his stay means he is
unlikely to be treated as a resident.

c) Since Smith appears to have settled in Hong Kong and severed ties with Papua New
Guinea, he would be a resident of Hong Kong and not Papua New Guinea.

Page | 31
d) Wayne is not a Papua New Guinea resident; he has not been in Papua New Guinea for
more than 183 days in either year of income.

e) Greatest is not a Papua New Guinea resident; she has not done anything to establish
residence in Papua New Guinea. Mere intentions are not decisive.

f) The company is a resident of the USA and not of Papua New Guinea provided the central
management and control is not in Papua New Guinea and provided the voting power of
the company is not controlled by Papua New Guinean residents.

g) The company is a resident of New Zealand and Papua New Guinea but see the provisions
to (f).

h) The company is a Papua New Guinea resident; incorporation in Papua New Guinea is
sufficient to create residency. If the company is also a Canadian resident, article 4(4) of
the Canadian double tax agreement may need to be considered.

i) The company is a Papua New Guinea resident; see Malayan Shipping Co Ltd v FCT
(1946) 3 AITR 258.

Bear in mind that double tax agreements can modify the definition of a person’s residence for
the purposes of the agreements because they override domestic tax legislation.

Page | 32
Self-Assessment Test

Question 1

Is an amount received by a company to compensate for loss of earnings caused by having a

project cancelled?

a) a windfall gain because the company was not expecting the payment,

b) Capital because the money would be an enduring benefit to the company,

c) Assessable income because it was an amount received to replace loss of earnings, or

d) Capital because it was only received in one lump sum by the company

Question 2

Mr M. Jordan is a US citizen conducting basketball clinics in PNG for three weeks because
he needs the money. He is being paid by a US mining company which has not set up business
in PNG but wants local people to think well of it when they start looking for gold next year,
the income not assessable because:

a) Mr Jordan is not a PNG resident,

b) R Jordan receives the money from a US company which is not resident in PNG,

c) Mr Jordan learned to coach basketball in the US, so the money has a US not PNG source,
or

d) None of the above because the income is assessable here, having a PNG source

Question 3

PNG senior public servant, Wari Tumas, has hit the jackpot at the pokies and has been advised
by a well-meaning friend at the IRC that his winnings are taxable. You tell him:

a) He won the money during working hours, so he is taxable

b) He plays so often that he would be considered a professional gambler, so he is taxable

c) He has never claimed any losses, so he is not taxable

d) It is a windfall gain or similar, so he is not taxable

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Question 4

Former Papua New Guinea business identity, Ima Pirot, has made his home in Monaco and
moved his family, all his furniture, bank accounts vehicles and other possessions there. He
comes back every year to check that his real estate agents, Bone Idle Ltd, are collecting the
rent from his office tower and residential complexes.

In 2012, he took a few side excursions to the Sepik and stayed over with friends so that he
was in Papua New Guinea longer than 6 months. Is he:

a) A tax resident in Papua New Guinea because he was here longer than 6 months

b) A tax non-resident because he has a permanent place of abode in Monaco

c) A tax resident because his income comes from Papua New Guinea real estate and he still
oversees the business

d) Tax non-resident because he is not a Papua New Guinean citizen

Question 5

Harbinger Doom, the company accountant for Icarus Airlines, comes to see you. He had
received K100,000 payment in advance in 2012 for airline tickets to be used by various 2013
election candidates. He would prefer the company not to be taxed on this receipt in 2013
because he would like to defer payment of his taxes.

You tell him:

a) Icarus is assessable in 2012 because they are a small airline that should operate on a cash
basis

b) Icarus is assessable in 2012 because the accruals basis says that is when the sale is made

c) Icarus is assessable in 2013 because the accruals basis says that is when the sale is made

d) Icarus is assessable in 2013 because the Act allows him to defer payment of his taxes

Question 6

Underground Oil Company Ltd, a company incorporated in PNG, has moved its
administration office to Cairns to save costs. The move has been so successful that all
activities take place there, including directors’ meetings, management meetings and activities
and accounting functions. You are specifically asked to give advice on the basis that the
Double Tax treaty between the two countries is not effective because there may have been a
slip up when it was signed. That being the case you advise that the company will:

a) considered by PNG tax authorities to be a resident of Paua New Guinea because it is

incorporated in Papua New Guinea

b) considered by Australian authorities to be a resident of Australia because its central

management and control is there

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c) both of a a) and b)

d) neither of a) nor b) because a company can only be resident in one place

Question 7

You are preparing the tax return for the year ended 31 December 2012 for a client who is a
prosperous citizen and resident in Papua New Guinea. He has several bank accounts with
Westpac in Cairns deriving interest income. Your view is that the interest is:

a) assessable to him because it is income derived as a resident of Papua New Guinea and
there is no exemption which applies

b) not assessable because it is not Papua New Guinea source income

c) exempt under Section 35 of the Act because the income is derived from a foreign
currency deposit

d) none of the above

Question 8

Roger Jolley has done well from his shipping because and has commenced building a block
of flats in Port Moresby to make money from the high rents due to the housing shortage there.
Before the building is complete, he receives an offer that is too good to refuse from Hasta
Lavistra, an Italian lawyer he knows, and sells at a large profit. You tell him:

a) the profit is assessable because he intended to make a profit when he sold it

b) the only reason the profit is not assessable is because he is not normally in the real estate
business

c) the profit is not assessable because he was not intending to sell at a profit when he
acquired the property

d) none of the above

Question 9

A client comes in and asks you to request the IRC to amend his previous income tax
assessments because his employer has been paying his wife alimony direct from his gross
wages and he never sees the money. You tell him:

a) take the deal that is offered because no payment is taxable

b) refuse the deal that is offered because he will pay tax on both the lease and the last
payment as he has made a profit on sale of the business

c) refuse the deal because he will pay tax on both the lease and the last payments as there
are a stream of payments

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d) ask that all the payments be termed capital instalments for the sale of the business, so
your client won’t pay tax on any of the payments

Question 10

A client comes to you to ask your advice about the sale of his food bar business. The purchaser
is prepared to lease the business from him for 2 years at a fixed payment, followed by a large
payment to purchase the business at the end. The purchaser is indifferent as to whether the
lease is structured as a lease or as an instalment sale provided, he only pays what he has
offered. You advise your client to:

a) take the deal that is offered because no payment is taxable

b) refuse the deal that is offered because he will pay tax on both the lease and the last
payment as he has made a profit on sale of the business

c) refuse the deal because he will pay tax on both the lease and the last payment as there
are a stream of payments

d) ask that all the payments be termed capital instalments for the sale of the business, so
your client won’t pay tax on any of the payments

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Answers: Self –Assessment Test

Question 1

c) is correct. While the payment appeared to be a capital one because it was unusual hence
seemed to pass the enduring benefit of once and for all tests, it was an amount which is
expected when one is running a business. Because the amount was paid to replace lost income
the better view is that it is income itself, rather than payment of a capital sum.

Question 2

c) is correct. The source of personal exertion income is generally where the duties are
performed, even if the receive is not a resident of Papua New Guinea. Mr Jordan did his
coaching in Papua New Guinea, so the income has a Papua New Guinean source.

Question 3

e) is correct. One has to look at the character or nature of the receipt in Tumas’ hands. The
fact that he should have been at work at the time does not make it income. Given that he is a
senior public servant it is extremely unlikely he would be a professional gambler but, in any
case, it would be unlikely that anyone playing the poker machines would be considered a
professional gambler because they are relying on luck to win, not their own gambling skills.

A gambling win of this kind will almost always be a windfall gain and not assessable.

Question 4

b) is correct. He does not ordinarily reside in Papua New Guinea, but he might be considered
resident in PNG because he was here for longer than 6 months.

However, on the facts of Ima’s case the Commissioner General has to be satisfied that he has
established a permanent place of abode elsewhere and he has no intention of returning to live
here. Tax residence does not depend on citizenship so, this is not the reason

Question 5

c) is correct. A company which can legitimately state that a sale is not complete until after
the cash has been received from the sale of its service can rely on Arthur Murray’s case to
defer the point at which the income is taxed to a time when the sale is recognised. In airlines,
this can be when the passenger utilises the ticket he has paid for in advance.

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Question 6

c) Is correct because, without the impact of the PNG/Australia Double Tax treaty, both a) and
b) are correct. d) Is not correct unless there is a treaty in place between the two countries
because this is exactly one of the problems that Double Tax treaties are meant to address, as
a company would be resident of only one country for the purposes of the double tax
agreement. d) Would not be correct even if we had been allowed to assume there was a treaty
in place. A company may be resident in more than one country. For example, a company
incorporated in PNG remains a resident of PNG for the purposes of PNG income tax law even
if for the purposes of the PNG/Australia Double Tax treaty and Australian law the company
is a resident of Australia.

Question 7

a) is correct. The client is a Papua New Guinea resident so the fact that the income does not
have a Papua New Guinea source does not prevent it being taxed here.

Question 8

c) is correct and a) Is incorrect because, in the vast majority of cases, it is the intention at the
time of purchase or acquisition not the intention at the time of sale that determines whether it
is assessable under the provision relating to sale of assets acquired as part of a profit-making
scheme or undertaking. b) Is incorrect because, while it is a reason, it is not the only reason
it is not assessable.

Question 9

a) is correct. Section 13 ensures that the income will be taxable to him even though it is
removed from his grasp before he can spend it, and this is the reason b) Is wrong. C) Is wrong
and it is an important principle to remember. Even if a payment is not deductible to the payer,
say because it is capital or private in nature, that does not mean that the payment is not income
in the hands of the receiver. D) Is wrong because Section 13 operates and in any case, he is
the one who has worked to earn the money.

Question 10

a) is incorrect because the lease payments would clearly be income. b) Is incorrect because
there is no evidence that your client acquired the business for the purpose of profit making by
sale. c) Is incorrect because it is documented as the price for the sale of the business and it
does not become income just because it is one of the series of payments received from the
same source. d) is correct because it is possible to pay a capital sum in instalments provided
that the receipt is clearly capital in the hands of the receiver.

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3 ALLOWABLE DEDUCTIONS
Learning Objectives

After you have successfully completed the work in this unit you should be able to:

• Demonstrate a clear understanding of Section 68(I) which determines whether an item

of expenditure is an allowable deduction.

• Explain the meaning of terms used in Section 68(I) such as:

 Losses and outgoings.

 To the extent.
 Incurred.

• Determine whether a loss or outgoing is capital or revenue in nature.

• Apply case law to assist in determining the meaning of terminology used in Section 68(I)

The Income Tax Act is designed with a general deduction section and various sections
allowing a deduction for certain specific items. In this unit we shall consider in detail Section
68(I) which contains the general guidelines for what should constitute a tax deduction. Later
on, we shall examine provisions which govern specific deductions.

Section 68 (I) of the Act states:

SEC. 68 Losses and Outgoings

(I). Subject to Sections 68A and Division III, 10, all ‘‘losses and outgoings’’, ‘‘to the
extent’’ to which they are ‘‘incurred’’ ‘‘in gaining or producing’’ the assessable income or
are ‘‘necessarily incurred in carrying on a business’’ for the purpose of gaining or
producing that income, are allowable deductions except to the extent to which they are losses
or outgoings of ‘‘capital, or of a capital’’, or are incurred in relation to the gaining or
production of ‘‘exempt income’’.
(emphasis added)

It will be observed that the section sets out two categories of losses and outgoings which are
allowable deductions, (the two ‘‘limbs’’ of section 68(I), but then provides that even if a loss
or outgoing satisfies one of those tests, it will not be an allowable deduction to the extent to
which it is a loss or outgoing of one of three specified types.

Almost all of the words in section 68(I) have been subject to judicial interpretation and it is
necessary to study the components of this section against a background of case law to
understand its operations.

The key words and phrase in section 68(I) are:

1. ‘‘losses and outgoings’’

2. ‘‘to the extent’’

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3. ‘‘incurred’’

4. In ‘‘gaining or producing’’ the assessable income – (first limb); or ‘‘necessarily incurred

in carrying on a business’’ for the purpose of gaining or producing such income –
(second limb).

5. ‘‘capital, or of a capital nature’’ – (exclusion)

6. ‘‘private or domestic nature’’ – (exclusion)

7. ‘‘in relation to the gaining of or production of exempt income’’ – (exclusion)

Each one of those key words or phrases has been examined in detail in the following pages.

Losses and Outgoings

For the purposes of section 68 there must be a ‘‘loss’’ or ‘‘outgoing’’.

As explained in (see tax cases) Amalgamated Zinc (De Bavay’s) Limited v FC of T (1935)
54 CLR 295:

‘‘An ‘‘outgoing’’ must be an expenditure which has an effect in gaining or producing

assessable income’’

In contrast, a ‘‘loss’’ reduces income and arises outside the control of the taxpayer.

‘‘Notional’’ losses or outgoings will not be deductible e.g. intra-company transactions such
as charges made by office to a branch. [Max Factor and Co v FCT. 84 ATC 4060].

Refer to the section on tax cases in this unit for further commentary on the cases quoted
throughout this unit.

To the Extent

The Apportionment of Expenditure

Losses and outgoings may relate partly to the gaining or production of assessable income and
partly to something else,

Therefore, section 68(I) permits the dissection and apportionment of losses and outgoings.

E.g. Ronpibon Tin NL v FCT (1949) 78 CLR 47. In the Ronpibon case, the High Court ruled
that a tin mining company which had derived only investment income during the relevant
year, was only permitted to claim a deduction for that part of its administrative expenses which
related to its assessable investment income. So much of its expenditure which related to the
maintenance of a corporate structure with a view to resuming tin-mining operations after the
end of the war was held to be of a capital nature and non-deductible.
Reasonableness

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The orthodox view is that section 68(I) does not restrict allowable deductions to amounts
which are commercially reasonable. This view was expressed as follows in the Ronpibon
case.

‘‘It is important not to confuse the question of how much of the actual expenditure of the
taxpayer is attributable to the gaining of assessable income. The actual expenditure in gaining
the assessable income, if and when ascertained, must be accepted. The problem is to ascertain
it by an apportionment. It is not for the Court or the Commissioner to say how much a
taxpayer ought to spend in obtaining his income but only how much he has spent’’.

Several recent Federal Court decisions in Australia give the appearance of departing from this
orthodox view. As the general deduction provision in Papua New Guinea is almost identical
to the Australian general deduction provision, as a matter of practice, the Papua New Guinea
revenue authorities will normally follow the principles established in Australian tax cases
although they are not bound by them.

For example, in FCT v Forsyth 81 ATC 4157 which concerned payments of rent to the
taxpayer’s family trust in respect of a home study, the Court referred to the Ronpibon principle
as follows:

‘‘If that statement were applicable in circumstances such as these, and if the outgoings were
allowable under [the relevant section] there would be potential for abuse in other cases’’.

Incurred

When a loss or outgoing is incurred?

Before losses or outgoings can be deductible for assessable income they must be ‘‘incurred’’.
There continues to be considerable uncertainty at law as to when this takes place.

In practice, a taxpayer who returns his assessable income on a cash receipts basis is ordinarily
treated as incurring allowable deductions on the same basis. However, this is not technically
correct as the basis for claiming deductions is when expenditure is ‘‘incurred’’ which is an
entirely different concept to when income is derived. Nevertheless, most of the difficulty in
the definition of ‘‘incurred’’ arises in relation to taxpayers who account for their expenditure
on an accrual’s basis.

The leading authority on the meaning of ‘‘incurred’’ is FCT v James Flood Ltd (1953) 88
CLR 492.

This case is supported by the more recent case of Nilsen Development Laboratories v FCT
81 ACT 4031. The Court stated in this case that there should be a ‘‘present liability to pay
money, and then, and only then, (is there) an outgoing which is deductible under… (the
relevant section)’’. A ‘‘present liability’’ will arise when certain events occur such as the
‘‘taking of leave is fixed and the period of leave is entered upon.’’

Note that the fact that expenditure has been incurred in a given year does not necessarily mean
that it is always entirely deductible in that year. This is particularly so if the expenditure
represents the prepayment for a benefit which is to be derived, either totally or in part, in a
subsequent year of income, the deduction allowable in respect of that expenditure shall not
exceed the value of the benefit derived during that year of income (s68AC).

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In ‘‘Gaining or Producing’’ The Assessable Income – (First Limb); Or ‘‘Necessarily
Incurred in Carrying On A Business’’ For The Purpose Of Gaining Or Producing Such
Income – (Second Limb)

These two tests are commonly referred to as the two limbs of section 68(I).

Meaning of the First Limb:

The first limb clearly requires a nexus (connection) between the incurring of loss or outgoing
and the gaining or production of assessable income.

How clear and direct must this nexus be?

The Courts have found that there is no requirement that assessable income actually be
produced as a result of the expenditure. Ronpibon Tin NL v FCT (1949) 79 CLR 47, the High
Court stated:

‘‘to come within (the first limb) it is both sufficient and necessary that the occasion
of the loss or outgoing should be found in whatever is productive of the assessable
income or, if none be produced, would be expected to produce assessable income’’

Meaning of Second Limb:

The second limb applies only to losses or outgoings that are incurred in carrying on a business.
(Note that business as defined in Section 4(I) and specifically excludes ‘‘occupations as an
employee’’).

The second limb does not require the taxpayer to establish a causal link between the loss or
outgoing and a return in dollars of assessable income, rather the requisite nexus is between
the incurring of the loss or outgoing and carrying on a business.

If the taxpayer is carrying on a business for the requisite purpose and there is a nexus between
the loss or outgoing and the business, then the second limb test is satisfied even if no income
nexus is immediately obvious: Herald and Weekly Times Ltd v FCT (1932) 48 CLR 113,
Neville & Co Ltd V FCT (1937) 56 CLR 290.

Under the second limb, it must be shown that the expenditure is necessarily incurred in
carrying on a business for the requisite purpose. The word ‘‘necessarily’’ does not appear in
the first limb. However, the term has been read down in Ronpibon Tin NL v FCGT to mean
no more than ‘‘clearly appropriate or adapted for’’ the income – producing business.

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Relevance of ‘‘Purpose’’:

Although the word ‘‘purpose’’ is used in Section 68(I) it does not refer to the purpose for
which the loss or outgoing was incurred. It refers to the purpose for which the taxpayer’s
business is carried on. Prima facie, in applying the section 68(I) test to a particular expense,
there is no need to consider the taxpayer’s purpose for incurring the expense. It is sufficient
that the expense was incurred ‘‘in gaining or producing assessable income or in carrying on
a business for the purpose of gaining or producing assessable income’’.

Income Production Yet to Begin or Already Ended:

It is not necessary that expenses actually be incurred in the year in which assessable income
is produced, provided that it can be established that the expenditure validly relates to the
production of assessable income at some time, or the carrying on of business for that purpose
[AGC Advances Ltd v FCT (1975) ATC 4057].

Expenditure that does not result in the production of assessable income in the year in which
it is incurred will be deductible if it: -

i) Relate to the production of income in future years [FCT v Finn (1961) 106 CLR 60]:

ii) Relates to the production of income in previous years in the course of continuing
business (which has not ceased):

iii) Will result in producing future costs, thus contributing to greater taxable (rather than
assessable) income [W. Nevill & Co. Ltd v FCT (1937) 56 CLR 290]: and

iv) Is genuinely incurred as part of or in the course of producing assessable income, [Charles
Moore & Co Ltd (1956) 95 CLR 344], even if it does not of itself directly produce
income but is part of the process.

In many situations, expenses incurred before income production has begun will be capital in
nature because they relate to the acquisition or establishment of the business. But even if not
capital in nature, they may give insufficient connection with the production of income. Thus,
in Softwood Pulp & Paper Ltd v FCT (1977) ATR 101 certain feasibility study expenses
relating to a proposed business venture were held to the non-deductible. The Court held that
the expenses were entirely preliminary and directed to deciding whether or not an undertaking
would be established to produce assessable income.

In the Travelodge case [Travelodge PNG v IRC (1985)] it was held that interest incurred on
a loan for the construction of hotel premises, prior to the opening of the hotel, was an
allowable deduction. However, a Hong Kong case (Wharf case) later reached a contrary
conclusion and considered the Travelodge case as incorrectly applying the law. A more recent
case in the High Court of Australia (Steele’s case) supported the conclusion reached in the
Travelodge case and considered interest paid before commencement of business operations
was of a revenue nature. In Papua New Guinea this issue is dealt with Sections 68 (5) and
(6) of the Act which in broad terms require interest incurred, prior to the later of when
taxpayer first derives assessable income or first uses the item for income producing purposes,
in connection with the acquisition or construction of an item of plant or a capital asset to be
added to the cost of the asset.

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The Proper Taxpayer:

A loss or outgoing is not deductible under section 68(I) unless it is incurred in gaining or
producing the assessable income or in carrying on a business of the person who incurs it:
FCT v Munro (1926) 38 CLR 153.

Capital

Losses or outgoings which satisfy the criteria for deductibility contained in the first or second
limbs of section 68(I) will not be eligible for deduction under that section to the extent to
which they are losses or outgoings of capital nature.

The Courts have formulated three main tests to assist in determining whether an item is capital
or not. These tests are: -

a) The ‘‘Enduring Benefit’’ Test

This test was enunciated in British Insulated & Health Cables Ltd v Atherton (1926)
AC 205:

‘‘When an expenditure is made not only once and for all, but with a view to bring into
existence an asset or an advantage for the enduring benefit of a trade, I think that there
is very good reason for treating such an expenditure as attributable not to revenue but
to capital’’.

b) The ‘‘Once and for All Test’’

Enunciated in Vallambrosa Rubber Co Ltd v Farmer (1910) 5 TC 529:

‘‘Capital expenditure is a thing that is going to be spent once and for all, and income
expenditure is going to recur every year’’.

c) The ‘‘Business Entity’’ Test

The leading authority on this test is Sun Newspapers Ltd v FCT (1918) 61 CLR 37.

The principle can be described by the analogy of ‘‘fruit on a tree’’. The fruit which
represents expenditure is deductible whereas the tree which is the profit-making
structure can only be referred to as being capital and therefore non-deductible.

The three tests were recently referred to by his Honour Hill J in a single judgement of
the Australian Federal Court in Pine Creek Goldfields Ltd v FC of Taxation (1999)
where a gold mining company claimed a deduction for the costs of diverting a road
where the life of a mine would have been reduced by one year if the road had not been
diverted.

Hill J held the expenditure was not of a capital nature and therefore the taxpayer was
entitled to a deduction under Section 51(I). The key factors in reaching this decision
were:

• the taxpayer did not acquire some proprietary rights or asset which it did not
previously own (business entity test);

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 • the advantage gained by the taxpayer was not an enduring one as the expenditure
only led to the continuation of the business for the purposes of earning assessable
income (enduring benefit tests);

• expenditure was of a kind which an open cut miner could be expected to incur
from time to time where the mine is adjacent to a highway and thus was an ordinary
outlay of the business of an open cut miner which produced advantages of a
revenue, rather than of a capital, nature (once and for all test).

The difficulties in determining the various issues was demonstrated in Steele v Dc of T 1997
where the taxpayer entered into a contract to purchase a 7.4-hectare property (‘‘Tibradden’’)
to be used for the agistment of horses. She intended to redevelop the property by building a
motel on it, but in the meantime would continue to use it for agistment purposes.
Subsequently, however, difficulties arose between the construction company and the taxpayer
and, after unsuccessful attempts to auction and partition the property, they sold the property
in two lots in 1986 and 1988.

The taxpayer claimed deductions for holding costs of the property incurred in the 1980/81 to
1986/87 years totalling over $900,000. These costs were predominantly interest payments on
borrowings used to acquire Tibradden, but included rates, land tax and other associated
expenses. Australian Appeals Tribunal (AAT) found that the taxpayer had a dual purpose in
acquiring Tibradden. Her main or dominant purpose was to erect a motel on the site and her
subsidiary purpose was to derive assessable income from the agistment activities. The AAT
allowed a deduction for an amount equal to the income derived from the agistment business
but held that the balance of the holding costs was not deductible because the nexus between
the expenditure and any future income was too remote. This expenditure was incurred to
‘‘develop a profit-yielding structure of a future business enterprise – an affair of capital.’’ A
majority of the Full Federal Court (Burchett and Ryan JJ, Carr J dissenting) concluded that
the advantage sought by the interest payments was the creation of a capital asset (a motel
complex) which was intended to be used at a later date for income-producing purposes. That
determined the character of interest payments, which were not part of the recurrent operations
of any existing business activity (leaving aside the agistment activities); and must capital work
and expenditure was required before Tibradden could become the income-producing property
which was proposed.

On appeal to the High Court of Australia, a majority joint judgement, their Honour Gleeson
CJ, Gaudron and Gummow JJ, held that as the interest payments were recurrent payments to
secure the use for a limited term of loan funds, it was proper to regard the interest payments
as revenue items. Their character was not altered by the fact the borrowed funds were used
to purchase a capital asset. The fact that the asset may never become income producing may
be relevant to whether the case falls within the first limb However, once it is determined that
the interest is, during the relevant year, an outgoing incurred in gaining or producing the tax
payer’s assessable income, the fact that the capital asset has produced no income is no reason
to conclude that the interest is of a capital nature.

Private or Domestic Nature

Losses or outgoings of a private or domestic nature are non-deductible.

This exclusion from deductibility should only affect individual taxpayers as it is difficult to
classify expenditure from a company’s perspective as private or business.

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Amongst the amounts which have been denied deductibility have been nursery fees for single
mothers, Lodge v VCT(1972) ATC 4174, and travelling expenses from home to work Lunney
v FCT (1958) 100 CLR 478 (although such expenses may be allowable where the home is
also considered to be a place of work or where the taxpayer travels to another place of work).
Occasionally special cases exist where what otherwise would be private expenditure for most
people (e.g. sunglasses for truck driver) is deductible.

Gaining or Producing Exempt Income

It is difficult to understand the need for these words, as the High Court said in the Ronpibon
Tin case:

‘‘To except losses and outgoings to the extent to which they are incurred in
relation to the gaining or production of exempt income seems to except
something from the primary description which could not fall within it.’’

Since exempt income can never be assessable income, expenditure incurred in gaining it
would not be deductible under the positive limbs of section 68(I).

Tax Cases: Allowable Deductions

Principles of ‘‘Losses and Outgoings’’

‘‘Losses’’ have been held to include:

• An amount of money stolen [Chalres Moore & Co (WA) Limited FCT (1956) 95 CLR
344]:

• The discrepancy between the cost of stock in trade and its proceeds [Investment &
Merchant Finance Co Limited v FCT (1971) 125 CLR 249]: and

• Bad debts written off [AGC (Advancers) Ltd v FCT (1975) 132 CLR 175]

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Amalgamated Zinc (De Bavay’s) Ltd v FCT – (1935) 54 CLR 295: 3 ATD 88 full High
Court of Australia

From the date of its incorporation in Victoria in 1909 until 1924, the taxpayer company
carried on the business of producing zinc concentrates and other metalliferous substances at
Broken Hill. IN 1924, the company ceased these mining operations and thereafter its only
income was derived from investments. From the end of 1920, workers’ compensation
legislation required all mine owners to Broken Hill to make annual contributions to a fund to
be applied towards making compensation payments to Broken Hill miners who had or may
in the future contract pneumoconiosis or tuberculosis. Where a miner died of such diseases,
payment was to be made to his dependants. The taxpayer company contributed to the fund
and was required to do so even after it had ceased mining operations in 1924. The company
claimed a deduction for the contributions it had made to the fund in 1932 and 1933.

Held: The contributions were not deductible. The company had abandoned the income-
producing operation out of which the necessity to make the outgoing arose. Consequently, it
could not be said that the outgoing was incurred in the gaining or producing of assessable
income.

Principles of ‘‘Extent’’

Ronpibon Tin NL v FCT – (1949) 78 CLR 47; 4 AITR 236; 8 ATD 431
Full High Court of Australia

The taxpayer was an Australian mining company. Its principal activity was tin mining in
Siam but its operations there ceased when that country was occupied by Japan during World
War II. After the cessation of its Siam operation, the company’s only income was derived
from investments. It did, however, maintain its administrative and office structure in
Australia partly with a view to recommencing tin mining in Siam at the conclusion of
hostilities. The company claimed a deduction for the expenses it incurred preserving its
administrative structure.

Held: The taxpayer was only entitled to a deduction for that proportion of the expenditure
which was preferable to the gaining of income from its investments. As the mining operations
had ceased and were thus not producing income, any outgoings related to that activity were
not deductible. It was also held that, whereas in this case, a taxpayer’s overall expenditure
must be apportioned between several objects of that expenditure, the apportionment must
reflect the actual intentions of the taxpayer when incurring the expenses. The apportionment
cannot be determined by the application of a fixed rule.

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Ure v FCT * 81 ACT 4100

Deane & Sheppared JJ took the view that where there is no obvious commercial explanation
for an outgoing, the Court may look to the indirect objects and advantages which the taxpayer
sought in making the outgoing. In that case, the taxpayer had borrowed money at commercial
rates and had on-lent them at 1% to related parties. The moneys were ultimately applied in
discharging a mortgage over residential property owned by a family company, in purchasing
a new residential property for a family trust, and in making interest bearing deposits. The
Federal Court upheld the Commissioner’s apportionment of the interest expenditure and only
allowed a deduction for an amount equal to the taxpayer’s interest income of 1%. (See also
discussion on Gwynvill Properties Ltd v FCT, FCT V Just Jeans Ltd and Fletcher and Ors v
FCT, later in this section).

The issue of apportionment was considered by the Privy Council in the two leading New
Zealand cases of CIR (NZ) v Europa Oil (NZ) Ltd (No 1) 70 ATC 6012 and Europa Oil (NZ)
Ltd (No. 2) v CIR 76 ATC 6001.

Whether and to what extent the Europa Oil cases are applicable to section 51(I) of the
Australian Act (Section 68(I) in Papua New Guinea) was considered by the High Court in
FCT v South Australian Battery Makers Ltd 78 ATC 4412.

The Court in that case was required to consider whether the entire amounts paid by the
taxpayer as rent was deductible or whether the rent should be apportioned in two parts, one
part of which was attributable to the right of possession under a lease and was therefore of a
revenue character, and the other part attributable to the reduction of the price of land which
an associated company had an option to buy and therefore was capital.

The Court ruled the whole amount was deductible. It was permissible, in the majority’s view,
to consider an advantage gained by another person as a result of the payment when the
taxpayer neither shares in that advantage nor could secure its enforcement.

Principles of ‘‘Incurred’’

Emu Bay Railway Corp v FCT – (1944) 17 CLR 596

It was said by Latham J that ‘‘outgoings incurred’’ could not be limited to amounts actually
paid, but should include liabilities presently incurred, but not yet actually met. The existence
of the liability or obligation was sufficient. In that case, interest under debentures was only
payable if the company had made sufficient profit after other expenditure. It had not made
the required profit, so no interest was payable on the debentures. Under these circumstances
it was held that the liability to debenture interest was contingent only and not yet a legal
liability. Hence it was not ‘‘incurred’’ and therefore not deductible under [section 68(I)].

Again, in W. Neville & Co Limited v FCT (1937) 56 CLR 290, Latham CJ noted the use of
the word ‘‘incurred’’ rather than ‘‘paid’’ in [section 68] and said:

‘‘This language lends colour to the suggestions that, if a liability to pay money as an outgoing
comes into existence the quoted words of the section are satisfied even though the liability
has not been actually discharged at the relevant time’’.

In the James Flood case, the High Court went further in defining the ‘‘liability’’ or
‘‘obligation’’ required by [section 68(I)]. That case involved a claim by a company to deduct

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a sum which had been set aside as a provision for holiday pay. This sum had not been paid
at the end of the financial year. The High Court held that the sum accrued was not an outgoing
‘‘incurred’’ as the employees had not at the relevant time worked long enough to qualify for
the leave. Hence the taxpayer was not ‘‘definitely committed’’ to and had not ‘‘completely
subjected himself’’ to the expenditure. It was not more than impending, threatened or
expected. There was, at best, an inchoate liability to make the payments subject to a variety
of contingencies.

FCT v James Flood Ltd – (1953) 88 CLR 492; 5 AITR 576; 10 ATD 240

The taxpayer company, which carried on the business of motor-body builder and general
engineer, set aside a sum of money as a provision for holiday pay for its employees. The
company was legally bound by an industrial award to give its employees holiday pay although
the award recognised that certain events could cause an employee to lose his right to such
pay. The company claimed that the sums set aside were deductible under the Assessment
Act.

Held: The sums set aside were not deductible. As the taxpayer company’s duty to provide
holiday pay to any employee was subject to a variety of contingencies, it could not be said
that the taxpayer had ‘‘incurred’’ an outgoing. While section 68(I) does not require that there
should be an actual disbursement, it does require that the taxpayer be ‘definitely committed’
to an outgoing. On the facts, that requirement had not been met.

Ogilvy and Mather Limited v FCT – 90 ATC 4836

The full Federal Court rejected the taxpayer’s argument that an expense was incurred when
the taxpayer became legally committed to it. The taxpayer was an advertising agency whose
business was, inter alia (among other things), to act as broker for advertisers who wanted to
place advertisements. These became ‘‘non-cancellable’’ for a period of between 3 and 70
days before the advertisement was screened. At the beginning of the non-cancellation period
the agency accepted responsibility for paying the media outlet. However, the agency was not
actually involved by the media outlet and did not invoice its own client until after the
advertisement appeared. The taxpayer claimed amounts payable to media outlets as a
deduction at the commencement of the non-cancellation period, but the Court held that at the
time the taxpayer had not completely subjected itself to the liability, because during the non-
cancellation period, it was not ‘‘a matter of commercial certainty’’. Until publication, the
liability remained merely ‘‘threatened’’ and ‘‘impending’’ rather than ‘‘encountered’’.

The fact the difficulties may exist in quantifying the amount of an expense will not necessarily
mean that the expense has not been ‘‘incurred’’. In Commonwealth Aluminium Corp v FCT
(1977) ACT, the taxpayer had claimed a deduction for royalties payable to the Queensland
government. A new Act made a higher rate of royalty payable than under the old Act and the
taxpayer had appealed against the higher rate. The Commissioner claimed that the fact that
the Queensland Government might change the rate, or that the taxpayer’s appeal against the
higher rate might succeed, made it impossible to say that the royalties had been incurred.

The Court rejected the Commissioner’s argument and held that although failure to make the
payments could lead to forfeiture of the lease, and there was a chance that the rate payable
may be varied, the royalty expense had nevertheless been incurred, and therefore a realistic
estimate of the amount so incurred would be deductible, whether paid at the time or not.
Similarly, in RACV Insurance v FCT (1974) 4 ATR 610, a deduction for claims actually

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made against the company together with a further deduction for claims not yet reported but
estimated as outstanding on an actuarial basis, was held to be a valid deduction despite the
fact that the latter was only an estimate.

Principles of ‘‘Gaining or Producing the Assessable Income’’ & ‘‘Necessarily Incurred

in Carrying on a Business for the Purpose of Gaining or Producing such Income’’

Various cases on the principles of ‘‘Gaining or Producing the Assessable Income’’ and
‘‘Necessarily Incurred IN Carrying On A Business For The Purpose Of Gaining Or Producing
Such Income’’ are shown below. The relevant issues discussed are shown in bold print with
the case summaries below.

What does the ‘‘second limb’’ (i.e., necessarily incurred in carrying on a business for
the purpose of gaining or producing assessable income) add to section 68(I)?

In John Fairfax & Sons Limited v FCT (1959) 101 CLR 30 to 40, the following attempt is
made to identify the ground covered in the second limb that is not covered in the first:

‘‘The first limb of Section 68(I) is…concerned with expenditure voluntarily incurred for the
sake of producing income… The second (limb) is concerned with where, in the carrying on
of a business, come abnormal event or situation leads to an expenditure which it is not desired
to make, but which is made for the purposes of the business generally and is reasonably
regarded as unavoidable.’’

Fullagar J quoted FCT v Snowden & Wilson Ltd (1958) CLR 431 as authority for this
proposition. In that case the taxpayer, a ‘spec’ builder (i.e. one who builds not to order but
takes the risk of selling the building as well), expended money to defend itself against
criticism in the West Australian Parliament and in appearing before a Royal Commission.
The High Court held the expenditure to be deductible under the second limb as being
necessary for the business, although not laid out to produce assessable income.

John Fairfax & Sons Ltd v FCT – (1959) 101 CLR 30; 7 AITR 346; ATD 510
Full High Court of Australia

The taxpayer, a newspaper publisher, and another publisher, Consolidated Press Limited,
were both attempting to gain control over Associated Newspapers Ltd, a rival publisher. The
taxpayer incurred legal expenses when Consolidated Press Ltd instituted proceedings for an
injunction to prevent the taxpayer purchasing further shares in the target company. The
taxpayer contended that the legal expenses were deductible.

Held: The legal costs were non-deductible outgoings of a capital nature. The legal expenses
were really part of the cost of acquiring the shares and a new asset.

Because of the generous approach that the courts have taken to the causal test in the first limb,
the practical difference between the two limbs is possibly not of great importance. In
Ronpibon Tin NL v FCT (1949) 78 CLR 47 the High Court said (at 577):

‘‘…in actual working (the second limb) can add but little to the operation of the (first limb).
No doubt the expression ‘’in carrying on a business for the purposes of gaining or producing’’
lays down a test that is different from that implied by the words ‘‘in gaining or producing’’.
But these latter words have a very wide operation and will cover almost all the ground
occupied by the alternative.’’

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This interpretation has received considerable judicial approval: John Fairfax & Sons Limited
v FCT (1959) 101 (CLR) 30 AT 48 Per Menzies J; FCT v Snowden & Willson Limited (1958)
99 CLR 431, per Dixon CJ.

Relevance of ‘‘Purpose’’

IN recent years, however, the Courts have asserted that it is appropriate to have regard to the
taxpayer’s purpose in cases where the plain facts do not explain why the expense was
incurred. This approach was first evident in Ure’s case, 81 ACT 4100.

Ure v FCT – (1981) 11 ATR 484, 81 ACT 4100

Federal Court of Australia

The taxpayer borrowed money at commercial rates of interest and in turn lent it to associated
persons (either his wife or his family company) at nominal rates of interest. The taxpayer
conceded that the interest he received was part of this assessable income but claimed that his
interest expenses were deductible under section 51(I) of the Assessment Act. The
Commissioner argued that the deduction should be limited to the amount of income derived
by the taxpayer from the borrowed money.

Held: The Commissioner’s assessment was upheld. On the facts, it was clear that the earning
of assessable income was only one of the purposes for which the taxpayer borrowed the
money. Accordingly, the expenditure had to be apportioned.

Income Production Yet to Begin or Already Ended

A leading case in relation to expenditure incurred after income production ended is

Amalgamated Zinc (De Bavay’s) Ltd v FCT (1935) 54 CLR 295. IN that cases, the High
Court was required to consider the deductibility of contributions made by a mine owner to a
workers’ compensation fund. These contributions had been made during the relevant year
notwithstanding that the taxpayer had ceased mining operations and only held basis that there
had been a complete cessation of the income producing operations out of which the necessity
to make the outgoing arose.

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The Proper Taxpayer

This maxim received a somewhat flexible interpretation EA Marr & Sons (Sales) Ltd v FCT
82 ACT 4654 although, in that case there was no evidence from which it could be inferred
that the transactions (the sub-leasing of plant to subsidiaries) would enable the subsidiaries to
pay dividends to the parent company. Rather, in that case, the Court held that the lease
expenses incurred by the parent company were deductible because they were incurred in
carrying on business of leasing plant from finance companies and making it available to
subsidiaries.

These Federal Court cases should, nevertheless, be contrasted to the remarks of Dixon J in
North Australia Pastoral Co Ltd v FCT (1946) 71 CLR 623 to the effect that subsidiary
companies are independent legal entities and that no deduction would be allowed to the parent
company for expenses incurred by it for the purpose of earning profits for the subsidiaries.

Principles of Capital

The ‘‘Enduring Benefit’’ Test

Broken Hill Theatres Ltd v FCT – (1952) 85 CLR 423; 5 AITR 296; 9 ATD 423
Full High Court of Australia

The taxpayer company operated a cinema in Broken Hill. It incurred legal expenses in
opposing applications by potential competitors for cinema licenses. In fact, over a period of
ten years it had opposed six such applications. The deductibility of the legal expenses was in
question.

Held: The legal expenses were non-deductible outgoings of capital. The taxpayer’s objective
in incurring the expenses was to protect its existing business by forestalling any new
competition. The fact that the expenditure did not bring into existence a new asset did not
mean that it could not be an outgoing of capital.

The ‘‘Once and for all Test’’

Vallambrosa Rubber Co Ltd v FARMER – (1910) 5 TC 529

Court of Sessions (Scotland)

The taxpayer company carried on business as a producer of rubber in Malaya. In the relevant
year of income, it incurred substantial expenses caring for its plantations. Some of those
expenses related to the annual weeding and supervising of young rubber trees which had not
commenced to produce rubber. The deductibility of that expenditure was in question.

Held: The legal expenses were outgoings of a revenue nature and therefore deductible. In
the course of his judgement, Lord Dunedin noted that: (I) an outlay which is going to recur
every year is more likely to be an outgoing of a revenue nature; and (2) to be deductible, it is
not necessary that the outlay produce assessable income in the same year as it was made.

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The ‘‘Business Entity’’ Test

Sun Newspapers Ltd v FCT – (1938) 61 CLR 37; (1938) CLR 337, 1 AITR 403; 5 ATD 87

‘‘The distinction between expenditure and outgoings on revenue account and on capital
account corresponds with the distinction between the business entity, structure or organisation
set up or established for the earning of profit and the process by which such an organisation
operates to obtain regular returns by means of regular outlay, the difference between the
outlay and returns representing profit or loss. As general conceptions it may not be difficult
to distinguish between the profit yielding subject and the process of operating it. In the same
way expenditure and outlay upon establishing, replacing and enlarging the profit yielding
subject may in a general way appear to be of a nature entirely different from the continued
flow of working expenses which are or ought to be supplied continually out of the returns or
revenue.’’

Sun Newspapers Ltd published an evening newspaper in Sydney. When it became aware that
a rival publisher intended to publish a new evening paper and sell it more cheaply than its
own paper, Sun Newspaper agreed to pay €56,500, by instalments, to the rival publisher in
return for the rival’s undertaking not to produce a newspaper in Sydney or within 300 miles
thereof for a period of three years. Sun Newspapers claimed the amount paid as an allowable
deduction.

Held: The moneys paid were in the nature of outgoing of capital and were therefore not
deductible. The chief object of expenditure was to preserve from immediate impairment and
dislocation the taxpayer’s existing business organisation: it was thus directed at strengthening
and preserving its profit-making structure. Consequently, the expenditure was of a capital
nature.

It is clear from the above discussion that expenditure which results in an addition to our
extension of the profit yielding structure is of a capital nature. But what of expenditure
incurred to protect or preserve a capital asset?

In Hallstroms Ltd Vfct (1946) 72 CLR 534, the majority of the High Court (Latham CJ, Starke
and Williams JJ) found that an amount expended in opposing the extension of a competitor’s
patent was not of a capital nature. Dixon J, however, with whom Tierman J agreed, though
that it was of a capital nature on the basis that it was really directed to more effectively
establishing the profit yielding structure. In John Fairfax & Sons Ltd v FCT (1959) 101 CLR
30, settlement costs in relation to a dispute between the taxpayer and another company over
the taxpayer’s title over shares in a target company were held to be of a capital nature. In
Broken Hill Theatres Ltd V FCT (1952) 85 CLR 423, the cost of opposing the grant of another
company over the taxpayer’s title over shares in a target company were held to be of a capital
nature.

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Self-Assessment Exercises

Question 1

Dockyards Ltd operates a large shipbuilding concern in Lae but ceased operations shortly
before Christmas due to a sudden downturn in orders. By the New Year, all of the company’s
assets had been disposed of and Dockyard (investments) Ltd was incorporated as a subsidiary
company to invest the proceeds of sale. Because of the close connection between the two
companies the latter company paid workers’ compensation claims which arose for settlement
after the former company had ceased operations.

Is Dockyard (Investments) entitled to a deduction for these amounts?

Question 2

Plantations Ltd was incorporated to undertake afforestation operations. Two items of

expenditure were incurred during the relevant year of income: clearing the land ready for
cultivation and weeding around newly sown trees.

Are either of these expenses allowable as deductions under the general provisions?

Question 3

Discuss whether a deduction would be allowable for each of the following:

a) Provision for the estimated amount of trade debtors accounts which might not be
collected.

b) Fines paid by a bookmaker for conducting illegal off course betting activities.

c) An amount of K450 paid to a solicitor for preparing a partnership deed.

d) The expense incurred by the production manager of a large firms travelling overseas to
purchase a new computer.

e) The cost incurred by company operating a drive-in theatre to reconstruct a public access
road, converting it from a gravel road into a more wear-resistant bitumen road.

f) Newspapers purchased by an accountant who advises clients on financial and investment

matters.

g) The cost of dog food and veterinary expenses in respect of two dogs used by a scrap
metal dealer as watchdogs.
h) The cost incurred by an insurance consultant for a home phone answering service used
to records calls while out. It is estimated that half of the calls recorded are private.
However, prior to accepting his position as an insurance consultant the taxpayer did not
have an answering service.

i) Travelling expenses incurred by a schoolteacher in using her own car to attend sports
afternoons. The sporting activities were at a nearby field and the only alternative means
of transport was to walk.

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Question 4

The Matsushima Motor Co Ltd is the Papua New Guinea subsidiary of a Japanese car
manufacturing company. It imports cars from its Japanese parent and sells them in Papua
New Guinea. The company has been enjoying considerable sales success in Papua New
Guinea and was rapidly overhauling local car manufacturers in sales volume. Because of the
threat to local employment if this situation continued, the Papua New Guinea government
announced its intention to impose a quota on the annual number of cars which could be
imported from Japan and sold in Papua New Guinea (assume such a system did not previously
exist).

In the current year of income Matsushima spends K950,000 on placing advertisements in the
Papua New Guinea media to petition parliament. The company is encouraging the public to
preserve their freedom of choice in obtaining the quality, low cost car which the company had
been importing and selling. The amount spent was five times the company’s normal annual
advertising expenditure.

Discuss the deductibility of this expenditure.

Question 5

Discuss whether the following are allowable deductions under Section 68(I).

a) The cost of moving machinery to a new site.

b) The cost of revaluing assets to effect insurance cover.

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Suggested Answers to Self-Assessment Exercises

Question 1

No deduction would be allowed: see Amalgamated Zinc (de Bavay’s) Ltd v FCT (1935 54
CLR 295). A taxpayer can claim deductions incurred after related revenue is earned. But they
must be of such a character that, in a continuing business, they will be met from time to time
as part of the process of gaining assessable income. The operations which made this outgoing
necessary had ceased.

In Dockyard Investment’s case, the expense does not seem to have the necessary nexus with
income earning activities.

Question 2

The question focuses on the distinction between expenses of a revenue nature and expenses
of a capital nature. The expenses incurred in clearing the land bring into existence an asset
or advantage which did not previously exist; they are expenses which are incurred once and
for all and which have a lasting benefit.

They are, therefore, expenses of a capital nature. On the other hand, the expenses incurred in
weeding are likely to give only temporary benefit, they are expenses which will recur and are
expenses which provide no lasting benefit. They are designed simply to protect or preserve
capital and not to enlarge or change it. They are therefore expenses of a revenue nature.

See Vallambrosa Rubber Co Ltd v Farmer1910) 5TC 529; British Insulated and Helsby
Cables Ltd v Atherton (1926) AC205 and Associated Newspaper Ltd v FCT (1938) 1 AITR
403. See also section 97 which applies to give an outright deduction to primary producers to
a variety of expenditure including expenditure on clearing land.

Question 3

a) A provision for uncollectable debts is not an allowable deduction: see RACV Insurance
Ltd v FCT (1974) 4 ATR 610. The event that brings about the loss has not yet occurred;
it is merely anticipated. Thus, no amount can be said to have been incurred.

b) Fines are not generally incurred in respect of activities as a trader and thus fail to meet
the first limb of Section 68(I). They are imposed as a personal deterrent for breach of
the law, not as incidental to income earning activities, and are private; see Mayne
Nickles Ltd v FCT (1984) 15 ATR 752. For an alternate view in relation to costs of
defending criminal proceeding see Magna Allows & Research Ltd v FCT (1980) 11
ATR 276.

c) Not deductible: expenditure was incurred as a prerequisite to earning assessable income;

it was not incurred in the course of earning assessable income. It also has a capital
nature being once only expenditure regulating the structure of the entity.

d) Assuming the new computer is not being acquired to become trading stock (in which
caser the travel expenditure would be deductible), acquisition of a new computer is an
asset to the firm and will give benefit in the future. It is therefore of a capital nature.

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 The expenses of travelling to buy the computer will therefore be of a capital nature and
will be excluded from section 68(I).

The position could be different, however, and the expenditure may be deductible, if it
was a regular part of the production manager’s job to travel and purchase assets etc. In
that situation, the character of the particular asset being purchased may not be as
prominent a factor in the decision on deductibility. Similarly, if the computer was only
a microcomputer being purchased at the same time as other non-capital assets, the
position may be different.

Nevertheless, in the situation under consideration, where a special trip is being

undertaken to purchase a large item of a capital equipment, it seems that the expenditure
incurred would be of a capital nature and should properly be treated as part of the cost
of acquiring the asset (i.e. added to the cost and depreciated). The taxpayer would need
to substantiate all travel expenses and keep a travel diary.

e) Expenditure was incurred to improve the road – making it into something better than it
was originally. It is therefore expenditure of a capital nature and not deductible under
section 68(I).

f) The expense is deductible under section 68(I) if related to the business. The nature of
the newspaper would be important. In order to succeed it would be necessary to
demonstrate that the particular publication contained information of particular or
peculiar relevance to the taxpayer’s occupation. Thus, a business-orientated newspaper
such as the Post Courier would seem to satisfy the required nexus, whereas a more
general mass market tabloid would be unlikely to have a sufficient correlation to the
income earning activities, unless it was possible to establish that a particular segment of
the newspaper was regularly used, and the newspaper would not otherwise have been
purchased. Apportionment may be necessary in a limited number of circumstances.

g) The expense is deductible under section 68(I); it has been incurred in gaining assessable
income (although the animals must be used for a business purpose and not be kept
merely as pets).

h) The expense is deductible, but is may require apportionment. If the service is

owned by the taxpayer, deduction may be by way of depreciation under section73.
Section 68(I) will be relevant if the equipment is leased or if there are additional charges
by the telephone company with owned equipment. Under s68(I), a deduction of 50%
of the cost of the service would be deductible. Any charges which varied with the
number of calls recorded would be apportioned to exclude the private costs. If there is
a flat rental fee independent of use, apportionment of that amount may not be required
if the taxpayer can successfully establish that the taxpayer would not have the service if
not needed as part of the taxpayer’s occupation.

i) Provided it is necessary for the teacher to attend the sporting activities as part of her
employment, and the travel is from the school to the field (as opposed to from home to
the field), the costs would be an allowable deduction. It is not for a court or the IRC to
say how much a taxpayer should spend on obtaining her income, but only how much is
spent. In other words, the IRC cannot say that the taxpayer should walk rather than take
her car. Even if it were not an absolute condition of her employment that she attend

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 sports afternoons, it would probably be seen as incidental and relevant or appropriate to
her employment in this case, and a deduction therefore allowable.

Question 4

The basic issue to be discussed is whether the expenditure is of a capital or revenue nature.
There would not appear to be much doubt that the expenditure was incurred as part of
Matsushima’s business. And would therefore fall within the positive limbs of section 68(I),
hence the issue is whether it is disqualified under the negative limbs as being of a capital
nature.

Arguments are available on both sides of the proposition. The important skill in answering a
question of this nature is to raise these arguments so as to demonstrate the ability to identify
them, then weigh them up.

First, the main argument in favour of it being capital expenditure would be that the new import
quota system threatened the structure of their business in Papua New Guinea (in other words,
the infrastructure under which they operated), and hence they were trying to protect and
preserve a capital asset with the expenditure. Alternatively, by its very nature a quota system
regulates the structure within which they operate.

However, it wold appear that the arguments for the expenditure being revenue expenditure
are stronger. First, the quota system does not really threaten the existence of the company’s
operations in Papua New Guinea, but merely threatens to limit the amount of income which
they can make from those business operations. Hence, the expenditure is merely protecting
their revenue contracts with their existing customers and the number of customers which they
could gain in the future. Also, wording in the advertisements such as ‘‘obtaining and selling’’
tends to indicate that the expenditure was also of a general advertising nature, and advertising
is generally a revenue type expense, hence it was also merely touting for business.

It should also be mentioned that the fact that the amount spent was five times the company’s
normal annual advertising expenditure is not necessarily of any relevance to a decision on
deductibility, as it is not for the Commissioner to say how much the company should spend
as part of its business; this is a commercial decision for the company. The commissioner is
merely concerned as to whether it was necessarily incurred as part of their business, meaning
merely that the relevant nexus to that business existed, and whether it was of a capital or
revenue nature.

Overall, it would seem that although some capital arguments are available, the revenue
arguments outweigh them, and the expenditure should therefore be deductible.

Page | 58
Question 5

a) The cost of moving fixed assets from one site to another would be capital expenses and
no deduction would be available under section 68(I). The cost of minor changes within
a site are regarded as deductible under section 68(I), since they are part and parcel of the
activities of carrying on a business.

b) Though the expenses relate to fixed assets, in determining deductibility it is relevant

whether the expenses enhance or enlarge income earning capacity or are incurred merely
to protect or preserve it. If the latter, and if the benefit is likely to be temporary and,
particularly, if the expense is likely to be recurring, then it should be deductible under
section 68(I). In this case, therefore, the cost of revaluing assets would be deductible.

Page | 59
Self-Assessment Test

Question 1

You are the company secretary to Mainland Rice Growing Company Ltd which plans to
establish a rice growing operation in the Highlands. They have already conducted enough
studies to decide that it will be viable to start growing rice there and they have gained the
necessary approvals and agreements with the landowners. The company now wants to
conduct a feasibility study to determine the best way to grow rice in order to maximise returns.
Will the expenditure on the study be?

a) Deductible because it is incurred with a view to producing assessable income in the

future

b) Deductible because there are a number of payments involved and the expense is
therefore not capital

c) Non-deductible because no assessable income has been earned in the year of

expenditure

d) Non-deductible because it is incurred at a point before the business has commenced and
hence capital

Question 2

Waigani Palm Oil Ltd wants to set up a plantation in some swampy areas to which it has title
and sets about reclaiming the land, removing some care wrecks and generally making it fit to
grow oil palm on. The company accountant comes to you and says that he has heard that he
may not be allowed a tax deduction in the company’s tax return because these are capital
expenses and asks if you have any tax planning ideas which would allow him to get the tax
deductions for the company. You tell him: -

a) The company has not earned any income yet, so it will be a capital expense and not
deductible. You suggest he does as little of the work as possible and leave the rest until
after the company starts deriving income from the land, so he can maximise his
deductions.

b) The expenses would normally be deductible but there is a particular provision which
operates where a business incurs expenditure in acquiring or building an asset and has
not yet commenced earning income or using the asset in question. This provision means
that the costs must be capitalised into the costs of the plant and depreciated but this is
not so bad as they eventually get the deduction by way of depreciation.

c) The expenses are deductible because they relate to agriculture even though they are
capital in nature, so everything is fine.

d) The expenses are deductible because they are incurred for many different items, such as
draining the swamp, cutting grass, removing car wrecks etc. and therefore they must be
revenue in nature.

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Question 3

Billy is a computer programmer who occasionally likes to come in to work on the weekends
when the office is quiet. He is not required to do that although it is appreciated by his boss.
He wants to claim his travelling expenses to get to work. You tell him:

a) His travel to and from work in regular office hours is not deductible but his out of hours
travelling is deductible because it is in excess of normal expenditure.

b) Neither his regular nor his out of hours travel are deductible because they are travel to
and from work.

c) Both is regular and out of hours travel is deductible because he could do his work unless
he got there in the first place.

d) His regular travel is deductible because he cannot work unless he gets there but his after-
hours travel is not because he does it by choice.

Question 4

Your company has a new expatriate accountant who spends his spare time reading the Papua
New Guinea Income Tax Act and he comes to you one day talking about the Travelodge case
which is summarised in the back of his copy of the Act. He mentions that there has been a
Hong Kong case which has cast doubt on the conclusion in the Travelodge case because in
that decision a Hong Kong Court found that interest incurred prior to the construction of an
asset used for the production of assessable income was in fact a capital expense and not a
revenue one, as held in the Travelodge case. He asks you whether you think this Hong Kong
case might be a problem in Papua New Guinea for people claiming such deductions. You tell
him:

a) No because the latter case was heard in Hong Kong and Papua New Guinea Courts
don’t take any notice of what happens in other courts if they have a Papua New Guinea
precedent.

b) Yes, because a Papua New Guinea Court would always have some regard to the
decisions of Courts in other countries even though they would view a Papua New
Guinea decision as setting up a stronger precedent.

c) No because the interest is not deductible in Papua New Guinea in any event

d) No because interest is deductible in Papua New Guinea as it is a revenue and not a

capital expense.

Question 5

Joe Laki of the General Disaster Insurance Company comes to see you about the deductibility
of claims made against insurance policies. He knows the company will get a deduction for
claim payments incurred during the year which means those that have arisen during the year
and been paid out and those that have been settled by the company, agreed to but not yet paid
out. He says to you ‘‘Look, every time we write a new policy we know that there is some
chance that a claim will be made because a certain percentage of our policies will always have

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claims made against them. If I know that some part of the business, we write will suffer
claims then can’t I get a tax deduction for those claims?’’ You advise:

a) No deduction is possible as all he can do is make a provision for a claim and provisions
are not deductible.

b) No claim has been incurred by the company until a claim is made by the policy holder
and so no further amount is deductible

c) Both a) and b)

d) A claim is possible because insurance companies have demonstrated in the past that the
chances of claims are so mathematically certain that they have incurred expenditure at
the end of each year for claims incurred but not yet reported to them.

Question 6

You are running your own business and have a constant battle with people that don’t pay their
bills. Over the years you have gained a reputation as a person who doesn’t give up easily but,
even with your efforts, some still don’t pay. When you strike the accounts after the end of
each year with assistance from your CPA qualified practitioner, you are very careful to write
off the bad debts that you think will never be recovered. Your practitioner tells you:

a) Because there is no hope of recovering the debts now, they will be deductible as bad
debts.

b) Is incorrect but as long as you can establish that the debts were not recoverable at year
end then you will get a tax deduction for them

c) Provided the debts you list were probably not recoverable then you will get a
deduction for them.

d) None of the above is true as the debts in question actually have to be written
off in the year of income before they will be deductible.

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Answers: Self-Assessment Test

Question 1

a) is incorrect even though the expenditure was incurred with a view to earning assessable
income in the future. The expenditure is incurred at a point in time too soon for it to be said
that it is incurred in the course of producing assessable income or carrying on a business for
that purpose. That is why d) Is correct. b) Is incorrect because taking a capital payment and
splitting it up into a number of payments does not turn a capital expense into a revenue one.
c) Is incorrect because it is not a requirement that the expenditure be incurred in the same year
that the income is produced.

Question 2

a) Would be correct but for the provisions of Section 97 which allows the deduction, and this
is the reason that c) Is incorrect and misleading. It refers to Section 68(5) and (6) which
operates to ensure that costs associated with constructing or acquiring an asset with could
otherwise be deductible (such as interest) are capitalised and depreciated if they are incurred
before (the later of) when the plant becomes income producing or income is first derived.
That is not the same as raising plants. d) is incorrect and is useful to remember why. A capital
expense does not become revenue simply because it is capable of being broken up into small
expenses. One has to look at the nature of the expense to determine if it is capital or revenue.

Question 3

a) is incorrect because additional travel is not deductible just because it is in excess of normal
expenditure. c) Is incorrect even though it is true that he could not start work unless he got
there first. This is essentially because he has not incurred the expense in the course of earning
his income. d) is incorrect in the first part for similar reasons as c). It is incorrect in the
second part because whether a person incurs an expense by choice is not relevant – the issue
is whether it has been incurred for the purpose of producing assessable income and does not
become disqualified under the other tests of Section 68(I). b) Is correct because the
expenditure, unfortunately for Billy, does not meet the tests of Section 68(I).

Question 4

c) is correct because Section 68(5) and (6) of the PNG Income Tax Act were passed by
parliament to nullify the decision in the Travelodge case. b) Would be correct if Section 68(5)
and (6) had not been passed but they were. a) Is also incorrect for this reason but a Papua
New Guinea court will always have some regard to overseas decision which are relevant to
the case at hand even if the court decides not to follow those decisions.

d) is also overruled by the amendments to Section 68. (The amendments disallow preliminary
expenses, including interest, but deem them to form part of the initial cost of a unit of
property).

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Question 5

d) is correct. The meaning of incurred attributed by the Courts is that a taxpayer must have
subjected itself to an expense and be capable of quantifying it precisely.

Because insurance companies have actuaries who are able to calculate the amount of claims
not yet reported at year end with great exactness they have convinced a number of different
Courts that they have incurred an expense relative to the insurance policies they have written.

Question 6

d) is true, the rest of the answers do not reflect the correct interpretation of the relevant section.
Your practitioner should be advising you to review your debtor’s ledger before year end if
you want to claim any relevant bad debts for that year and not be making a post balance date
adjustment for tax purposes.

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4 SPECIFIC DEDUCTION PROVISIONS
Learning Objectives

After you have successfully completed the work in this unit you should be able to:

• Determine the extent to which repairs may be claimed as a deduction.

• Explain how business losses may be claimed as a deduction.

• Explain the tax treatment of bad debts, and interest and borrowing expenses.

• Determine what tax expenses and legal expenses are allowable for tax purposes.

• Enumerate deductions available for rental property.

• Explain the extent to which sundry other expenses are allowable deductions.

• Describe limitations and restrictions on certain deductions, such as management fees.

• List and describe tax concessions mainly in the form of tax deductions.

In the last unit we considered the general nature and tax treatment of allowable deductions
and examined in detail the general provision for deductions, section 68 Income Tax Act. In
this unit we will examine certain tax provisions which contain specific rules for certain
deductions such as repairs, losses of previous years, interest and borrowing expenses, tax and
legal related expenses, and certain other expenses. There are also specific provisions for
calculating depreciation deductions which will be covered be covered in the next unit. These
expenses are covered in Division 3 - Deductions – of the Income Tax Act.

Repairs (Section 72)

The deductibility of an outgoing representing ‘‘a repair’’ is governed specifically by section

72 although in many circumstances a repair will be deductible under section 68(I).

A particular outgoing should be examined firstly under section 72 before section 68(I), in
accordance with the general rule of ‘‘specific over general’’ in interpreting statues. If a
deduction were available under both sections. Section 103 prohibits the claiming of a double
deduction.

The main problem in the area of repairs concerns whether or not expenditure on a repair is of
a capital or revenue nature.

A repair is the act of restoring to a sound or unimpaired condition. A repair is therefore a

revenue item and deductible under section 72.

However, where the act of restoring, results in an improvement to property, it will be regarded
as being a capital nature and non-deductible.

Initial Repairs

Repairs to a recently acquired fixed asset or ‘initial repairs’ are normally considered capital
in nature and therefore not an allowable deduction. They are regarded as part of the purchase

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cost of the fixed asset which was probably bought at a cheaper price as a result of being in
poor repair. However, it is necessary to look at each case individually.

In a recent decision of the Australian Appeals Tribunal [Case 10(98)] the roof of the motor
garage building was seriously damaged by a storm. As a consequence, the taxpayers engaged
a builder to undertake repairs. However, the builder reported that there was substantial white
ant infestation and that the basic structure of the roof was no longer viable and needed to be
replaced.

In due course, the following work was completed, a steel frame roof was pitched over the
whole building, a reinforced concrete floor replaced the old floor, the walls were replaced
with brick and masonry, a new and relocated toilet block was constructed, new conditioning
and a new oil separator were installed.

The AAT held that the taxpayers set out initially to make good the storm damage, but the
whole process of putting the building back into a viable condition eventually resulted in the
staged construction of a new building.

The initial work undertaken did not constitute improvements, even though the damaged
materials were replaced with modern equivalents. However, after this the facts feel squarely
within the principle in that if a thing is bough for use as a capital asset in the buyer’s business
and it is not in good order and suitable for use in the way intended, the cost of putting it in
order is part of the cost of its acquisition and not of its maintenance.

Improvement or Repair?

An improvement is not a repair. Where the work done does not result in the subject matter
being better functionally, the work would generally be characterised as a repair. Whilst there
is undoubtedly some degree of improvement effected by any repair, the improvement
generally only arises from the repair; the subject matter will always be ‘‘better’’ after being
repaired when it has been put back to its original condition. It is of course quite common for
repairs to be carried out with materials different from that originally used. For the work to be
characterised as a repair, the improvement in the subject matter must be a mere by-product of
the activity of putting the subject matter back into the original condition.

Where the repair is undertaken for the purposes of modernisation rather than simply
restoration, the expenditure would generally be characterised as a of a capital nature and
deductibility would be denied under section 72.

Apportionment

Section 72(3) provides for the apportionment of expenditure incurred on property only partly
used for an income producing purpose. The amount to be allowed as a deduction under
Section 72(3) is that which the taxation office considers reasonable in the circumstances.

Note that Section 68(I) also provides for apportionment of deductions.

Prior Year Losses (Section 101)

Taxpayers can carry forward losses incurred in one year for deduction against its assessable
income in subsequent years. A loss is defined as the excess of allowable deductions over
assessable income plus exempt income.

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Therefore.

Loss = Allowable deductions - Exempt income - Assessable income

Note that losses are first offset against net exempt income and then assessable income.

There is a twenty-year limitation on the carry forward of losses. In the 2001 budget, the loss
carries forward period was increased from 7 to 20 years. However, the law is not
retrospective. This means that losses previously written off under the 7-year rule cannot be
reinstated and claimed. So, losses incurred before 1994 cannot be claimed. Losses incurred
during the 1994 year which were due to lapse (under the former 7-year rule) during the 2001
year can be carried forward for the remaining 13 years until 2014 under the new 20 year carry
forward rule.

Primary production losses and resource operation losses can be carried forward indefinitely.

Losses may not be carried back to prior years.

Losses cannot be transferred to other companies within the same group.

Foreign losses are quarantined (i.e. can only be applied against) foreign income [section 66A
(3)]. Therefore, foreign losses are not allowable as deductions against Papua New Guinea
sourced income, but arguably may be carried forward to 20 years to be offset against foreign
sources income.

Example (1)

Year 1 Assessable income 10,000

Allowable deductions 14,000
Loss incurred 4,000
Allowable loss to be carried forward 4,000
Years 2 Assessable income 12,000
Allowable deductions 8,000
+ loss carried forward 4,000 12,000
Taxation income Nil

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Example (2)

Assessable income 4,000

Allowable deductions 6,000
Loss incurred 2,000
Less exempt income 1,000
Allowable loss to be carried forward 1,000
Taxable income Nil

The loss as calculated is an allowable deduction in the following year of income. If the
assessable income of that year is not enough to recover the loss, then the amount is again
carried forward to the following year. This can be done for twenty years (other than for
primary production losses, which may be carried forward indefinitely), but if not recovered
by then the deduction is lost.

Example (3)

A taxpayer had a steady stream of net exempt income of K30,000 per year. The results of his
business transactions for three consecutive years excluding the exempt income were as
follows:

2005 Loss 240,000

2006 Profit 80,000
2007 Profit 360,000

Taxable income for each year would be as follows:

Year of Income 2011

Net loss business 240,000
Deduct: Net exempt income 30,000
Loss carried forward 210,000

Year of Income 2012

Business Profits 80,000
Loss brought forward 210,000
Less net exempt income 30,000 180,000
Taxable income Nil
Loss carried forward 100,000

Year of income 2013

Business Profits 360,000
Loss brought forward 100,000
Less Net exempt income 30,000 70,000
Taxable income 290,000

In order to deduct losses against assessable income, the following steps should be taken, in
the order as shown:

1. Deduct all other allowable deductions first

2. Calculate net exempt income – if any

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3. If there is any assessable income remaining, then the previous years’ losses (less net
exempt income) may be deducted wholly or in part. It depends on the amount of
assessable income available.

4. Previous years losses are deductible in the order in which they were incurred

If a taxpayer is a salary or wage earner and incurs a non-salary loss, this loss shall be allowed
as a rebate against the salary or wage tax paid during the year of income. But such a rebate
cannot exceed the tax paid.

Limitation on the Deductibility of Prior Year Losses

Although a company may be entitled to a deduction for prior year losses, there are certain
conditions that must be satisfied in the case of companies, namely either:

• The Continuity of Ownership Test (section 101D) or, failing that

• The same Business Test (section 101G)

Continuity of Ownership Test

Section 101 D provides that a deduction for a loss will not be allowed unless the company
satisfies the IRC that at all times during both the year of loss and the year of income, there
was a continuity in the ownership of shares carrying the following rights:

• to exercise not less than 50% of the voting power.

• to receive not less than 50% of any dividends paid; and
• to receive not less than 50% of any capital distributions in the event of winding up, or
of a reduction in the capital of the company.

Section 101E (5) an operate to prevent the application of section 101D where there is an
agreement which could affect the right of the person who prima facie owns those shares.

Same Business Test

If the company fails to satisfy the continuity of ownership test under Section 101D, the losses
may still be deductible if it can satisfy the same business test of Section 101G.

Section 101G (I) provides that:

a) Where there has been a disqualifying change in beneficial ownership of shares.

b) The company continued to carry on the same business as it carried on immediately

before the disqualifying ownership change; and

c) The company did not derive income from a kind of business that it did not carry on, or
from a kind of transaction that it did not enter into, before the disqualifying ownership
change.

a deduction for previous years’ losses will be allowed.

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Whether a company satisfies the provisions of section 101G is a question of fact and degree.
However, case law summarised later in the unit support the following broad positions:

• It is not enough that the business is the same kind of business, it must be the identical
business (i.e. there must be a continuation of the old business, not a commencement of
a new business); and

• A company cannot satisfy the same business test if it ceases to carry on business in the
period immediately before the disqualifying change in ownership occurs.

Bad Debts (Section 85)

Section 85 of the Act provides that debts which are bad debts and are written off as such
during the year of income are allowable deductions provided that either:

(i) Those debts have been brought to account by the taxpayer as assessable income of any
year, or

(ii) The debts are in respect of money lent in the ordinary course of the taxpayer’s business
of money lending.

The following must be established to allow an effective claiming of a bad debt write-off as a
deduction under section 85:

(i) The debt must have been in existence, a legal or equitable claim. Therefore, writing off
should always precede any settlement or composition which would affect revocability
[Point v FCT] (1970) ATC 4021; GE Crane Sales (1971) 126 CLR 177].

(ii) It must be ‘‘bad’. As there is no definition of what constitutes a ‘‘bad’’ debt under the
Act, it will be a question of fact, supported perhaps, by appropriate professional opinion
as to whether a particular debt is in fact bad. Absolute irrevocability is not necessary.
However, it is not enough that a debt is doubtful, and the Act will not authorise a
deduction for the taxpayer’s provision for doubtful debts.

(iii) The debt must be written off as such during the year of income in which it is claimed,
not at a later point in time. Some form of written particulars is required, e.g. Minutes.
It is wise to remove the accounts from the receivable ledger by charging the provision
for bad and doubtful debts or the profit and loss account.

(iv) The debt must have been brought to account as assessable income or relate to money
lent in the ordinary course of the taxpayer’s money lending business to qualify for the
deduction.

Any recovery of amounts written off as bad debts in a previous year of income must be
included in the taxpayer’s assessable income [section 85(3)].

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Interest and borrowing expenses

Interest

In general, interest payable on funds used in a business is deductible (under Section 68)
without limitation, subject to the introduction of think capitalisation rules from January 2013
(refer below). There is usually no distinction made between interest paid on funds used as
working capital and that paid on loans used to purchase assets whose cost is not deductible in
full upon purchase.

Interest paid on loans during the construction of an asset, and before it comes into use to earn
assessable income, is not allowable as a tax deduction. This expense must be ‘capitalised’ as
art of the cost of acquiring the asset and be deducted by way of depreciation (section 68(5)
and (6)).

Thin Capitalisation Rules – section 68AF

From 1 January 2013 PNG’s thin capitalisation rules apply to all companies in PNG. Think
capitalisation rules had previously applied only to participants (licence holders) in a PNG
resource project.

Thin Capitalisation rules are intended to prevent taxpayers from incurring excessive levels of
debt. By excessively gearing their investments companies are able to claim greater tax
deductions through the interest expense charged on such debt. Thin capitalisation rules
typically feature a debt equity ratio which limit the amount companies can borrow from
related parties relative to their equity. If the prescribed debt to is exceeded, a proportion of
interest expense is treated as non-deductible.
The prescribed debt to equity ratios in PNG is:

(a) 2:1 for all companies other than resource companies and financial institutions,

(b) 3:1 for resource companies,

(c) The thin capitalisation rules do not apply to approved financial institutions – that is,
financial institutions are not themselves subject to a debt equity limit.

A key aspect of the thin capitalisation rules is that ‘‘debt’’ and ‘‘equity’’ are defined by
reference to accounting concepts and therefore will usually be drawn straight from the balance
sheet of the company (assuming the balance sheet is prepared in accordance with international
accounting standards).

‘‘Debt’’ is defined as the indebtedness of taxpayer as shown in a balance sheet prepared in

accordance with International Accounting Standards, and includes specifically:

• a credit facility for property or services (not trade accounts arising from ordinary
business).
• guarantees or similar.
• a credit facility secured by any lien upon property owned by taxpayer, or one of its
subsidiaries; or
• obligations of taxpayer under finance leases; or

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Equity consists of shareholders’ funds, including issued capital and accumulated income
(retained earnings), defined in accordance with International Accounting Standards.

If a taxpayer’s balance sheet is not prepared in accordance with International Accounting

Standards adjustments may be required to the balance sheet to calculate debt and equity and
determine compliance with thin capitalisation rules.

Formula to calculate interest deductibility – resource companies

The rules for determining the amount of non-deductible interest are different for resource
companies and other companies.

For resource companies the following formula is used to determine the amount of interest that
is tax deductible:

T1
x 3E
D

Where:

TI = total interest incurred in period re the project

E = equity in relation to the project
D = debt in relation to the project

The thin capitalisation for a resource company apply to all interest paid, whether paid to a
resident or non-resident of PNG and whether paid to an associate or unrelated party.

Formula to calculate interest deductibility – other companies

For non-resource companies the following formula is used to determine the amount of interest
that is tax deductible:

T1 x 2E
D

Where:

TI = total interest incurred in period re the project

E = equity in relation to the project
D = debt in relation to the project

The thin capitalisation rules for non-resource companies

Example

A resource company resident in PNG (‘‘PNG Co’’) borrows K100m from its overseas parent
company and incurs interest on the loan of K5m. PNG Co has K30m equity recorded on its
balance sheet.

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TI = K5m
E = K30m
D = K100m

In order to calculate how much of the interest expense tax deductible, the formula for resource
companies is applied as follows:

5m x (3x30)m
= 4.5 m
100m

In this case K4.5m of the interest expense is tax deductible, so the non-deductible amount will
be K500,000.

If the company was not a resource company, the calculation would be:

5m x (2x30)m
= 3.0 m
100m

In this case the non-deductible interest will be K2m.

An important distinction between the rules for resource companies and non-resource
companies is that the rules applying to non-resource companies operate to deny deductions
only for interest paid to non-residents of PNG. In the example above, if the K5m of interest
expense was paid to a resident of PNG the interest would be fully deductible, even though the
2:1 ratio is exceeded.

Borrowing Expenses (S.89)

Non-interest costs of borrowing money to produce assessable income are regarded as capital
expenses. They are not deductible in full in the year incurred but may be amortised (written
off) over five years or the period of the loan, whichever is less. The deduction appears to be
available even though no assessable income may be produced in the year in which the
deduction is claimed. Such costs for raising loans, including debentures, include brokerage,
advertising, valuation and survey fees, underwriter’s fees, prospectus fees, stamp duties, legal
fees and security negotiation costs.

Note the deduction is claimed over five years, not five years of income. Thus, if the taxpayer
borrowed halfway through the year of income half of one fifth of the costs would be
deductible.

Borrowing expenses of less than K100 in any one year are fully deductible in that year.

Example

A businessman on 1 January 2013 borrowed K100, 000 for six years from a bank and was
charged K2, 500 establishment fees. At the end of the year borrowing expenses may be
claimed as follows:

Allowable deduction = 1/5 of K2, 500

= K 500

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Tax related expenses

Section 68(9) specifically permits a deduction for expenditure incurred by the taxpayer for
the preparation by a registered tax agent of a return or information required to be submitted
to the IRC. However, this does not include deductions for expenses in objecting to and
appealing against tax assessments and a taxpayer would need to rely on Section 68(I) to claim
these expenses.

Under Section 68(I) indirect taxes such as GST and import duty are directly deductible if they
apply to such items as inventory or raw materials or otherwise related to expenditure incurred
for the purpose of earning assessable income.

Note that income tax, including company tax and salary and wages tax is not tax deductible.
Foreign income taxes are not deductible, but a tax credit is granted for such taxes against
Papua New Guinea income tax.

Legal Fees

Legal expenses incurred by a business in the ordinary course of its business operations are tax
deductible, provided they are not of a capital nature. Thus, legal fees for debt recoveries,
preparation of business forms, defending claims for faulty merchandise, handling wage
disputes and similar matters are fully deductible. However, Court fines as a result of breaking
the law are generally not deductible.

Legal fees relating to company formation, issues of share capital and transfers of real estate
are not allowable for tax purposes. Legal fees incurred in acquiring capital assets may be
capitalised as part of the cost, and depreciation claimed accordingly. These may include
conveyancing costs in connection with the purchase of property and legal fees relating to the
purchase of a business.

Expenses of Preparing a Lease (Section 90)

Expenditure which includes registration and stamp duty on a lease of property are deductible
in the year of preparation.

Superannuation Fund Deductions

Allowable deductions for employer’s contribution to an authorised superannuation fund

(authorised under the Superannuation act 2000) are limited to 15% of each employee’s fully
taxed salary or wages.

Gifts (S.69)

A deduction is allowed for gifts with a monetary value over K50 to certain Papua New Guinea
sporting bodies, approved charitable institutions and the Foundation of Law, Oder and Justice.
Gifts made to ‘recognised’ political parties are tax deductible only to a citizen or a company
that is wholly owned by a resident citizen. An example of a specific gift deduction is the
double deduction for donations made prior to 31 October 2005 to the 30th Independence Day
celebrations and to the Pacific Island Forum held in 2005 as announced in the 2007 National
Budget.

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Allowable deductions for rental property

A landlord is liable to pay tax on net rental income, however expenses related to the derivation
of such income are generally deductible, as follows:

• Interest on money borrowed for purchasing property or to fund any expenses of owning
the property,
• Rates, land taxes,
• Travel and other expenses connected with collecting rent,
• Repairs and maintenance,
• Agent’s commission for collection of rent,
• Tax return preparation expenses,
• Insurance,
• Management fees,
• Legal expenses in recovering arrears of rent or ejecting tenants for non-payment of rent,
• Expenses of preparation and stamping of leases.

Depreciation is also allowed on property rented out as well as on furniture and various
household items.

Legal costs of action for damage done to rent producing property are not allowable. Legal
fees and conveyancing costs in connection with the purchase of a property are not deductible.
However, they may be capitalised, and depreciation claimed.

Foreign Exchange Losses [S.64(4)]

Realised foreign exchange losses arising from the repayment of foreign currency debt are an
allowable deduction. The deductibility of realised exchange losses on other transactions such
as those relating to trade creditors or foreign currency deposits need to be considered under
the general deduction provisions of section 68(I).

Example

In 2011 ABC Company Ltd borrowed US$5 million, to be repaid two years later in 2013.
Exchange rate in 2011 when money was borrowed: K1 = US$1. ABC received K5 million
kina when the loan was converted into kina.

In 2013 when the loan was repaid, the exchange rate was: K = US$.74. In order to purchase
US$5 million ABC must convert K6, 756, 757. Because the kina has depreciated against the
dollar, the company has suffered an exchange rate loss of over K1.7 million. This loss is fully
tax deductible.

If the kina had increased in value, resulting instead in an exchange rate gain, the gain would
be treated as assessable income (S.47(i)(k).

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Limitations on Deductions

Leave Payments [Section 68(3)]

A deduction is not allowable for long service leave, annual leave, sick leave or any her leave
until such time the amount set aside has actually been paid. Therefore, provisions for these
types of leave are not deductible. However, a deduction is allowed when actual payments for
leave are made.

Preliminary Expenditure [Section 68(5)]

Expenditure, including interest, incurred on the construction or acquisition of an item of plant

or capital asset, which would have otherwise been deductible but for this section, will form
part of the construction or acquisition cost of the asset to the extent it is incurred prior to the
date:

• the taxpayer first derives assessable income, or

• the plant is first used to produce assessable income

Whichever is later.

Club Fees, Domestic Services, Security Services, Electricity, Gas and Entertainment
[Section 68(10)]

The provision to an employee (directly or indirectly) of club subscriptions or fees, domestic

services, electricity, gas, security or entertainment is non-deductible.

Business Entertainment [Section 68(II)]

Deductions are normally not allowable for expenses incurred in providing entertainment such
as food, drink or recreation (including associated travel and accommodation). The exceptions,
where entertainment expenses may be deductible, include:

• Entertainment provided by a taxpayer who is in the business of providing entertainment

(e.g. hoteliers).

• Entertainment provided for the purposes of promoting or advertising a business or its

goods and services to the general public.

• Entertainment provided in an ‘in house dining facility’.

• Entertainment provided at a work seminar (held between 8am to 5pm on working days).

• Entertainment provided to members of the public who are sick, disabled, poor or
otherwise disadvantage.

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Club Fees/Leisure Facilities (Section 68AB)

Losses or outgoings relating to the provision of club fees or relating to leisure facilities, such
as boats, are not allowable as a deduction.

Prepaid Expenses (Section 68AC)

A deduction for ‘‘prepayments’’ is denied where the benefit from the prepayment is to be
derived in a subsequent year of income. The major exception to this rule is a payment for
insurance.

Management Fees (S.68AD)

A management fee is defined as follows:

‘‘Management fee’’ means a payment of any kind to any person, other than to an employee
of the person making the payment and other than in the way of royalty, in consideration for
any services of a technical or managerial nature and includes payments for consultancy
services, to the extent the Commission is satisfied those consultancy services are of
managerial nature.

When management fees are paid to a ‘non-associated’ business (e.g. not being a relative,
partner or company under common ownership) they are treated as allowable deductions in the
normal way, provided they are not for the purpose of tax avoidance.

Management fees paid to an ‘associate’ have limits imposed on their tax deductibility. The
limits are aimed in particular at payments by resident companies to non-resident associate
companies. However, they also apply to inter-company payments within Papua New Guinea
and to payments between a partnership or an individual taxpayer and a service company.

Because the restriction imposed on management fees is aimed mainly at payments to overseas
companies, we shall consider the relevant tax provisions in more detail in Unit 8 - taxation of
non-residents and overseas income.

Taxation incentives for business and industry

Allowances and deductions for primary production

Expenditure on new plant or articles used in agricultural production qualify for 100% initial
depreciation (S.73.9). Primary producers are also allowed a full deduction of the capital cost
of clearing, preparing for agriculture, planting of land, eradication of pests, construction of
labourer’s accommodation, and conservation and conveyance of water (S.97). In other words,
these types of expenses can be treated as an expense when computing assessable income.

Under S.97B, new 150% tax deductions have been introduced for the provision of extension
series in agriculture and scientific research (research and development). The incentive for
expenditure on research and development extends to all qualifying research and development
and is no confined to expenditure incurred by primary producers.

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Investment in Primary Production (S.97A)

A primary production company which has incurred primary production development

expenditure (defined to include the costs of assets used for agricultural production) can
transfer the tax deductions to which they are entitled as a result of that expenditure, to
shareholders after lodging a declaration with the IRC. The amount transferred to each
shareholder is in proportion to the respective amounts of their paid-up capital. The total
deduction available to a shareholder may not exceed the total amount paid on their shares.

A primary production company wishing to surrender its deductions and transfer them to its
shareholders should lodge a declaration with the IRC within two months after the end of the
financial year.

Example

A primary production company incurred K500,000 development expenditure on a plantation

in a year of income. The company transferred the deductions available to it in respect of this
expenditure to its shareholders.

The formula for calculating the allowable deduction for each share held is:

Tax deductions transferred

number of shares issued

The company issued a total of one million paid up shares of one kina each. Tax deduction
allowable for each share held:

500,000
= 50 toea per share
1,000,000

A shareholder, therefore, with 1, 000 shares is entitled to a tax allowance of K500. A tax
rebate under Section 214 (i) would amount to k125 (500 x 25%).

If the shareholder was a non-salary (e.g. Business) income earner, the tax allowance of K500
would be treated as an allowable deduction.

Following the year of income, the primary production company will inform each shareholder
of their tax deduction entitlement to enable them to claim a tax refund.

Primary production losses (Section 101A)

Primary producers incurring losses can deduct such losses against profits made in future years,
until the losses have been cancelled out. Primary producers are not subject to the 20 years
limitation generally applicable. If a taxpayer has assessable income from other sources greater
than a loss incurred from primary production, then no loss is deemed to have occurred for tax
purposes.

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Timber operations (Sections 166 – 170)

Timber and logging companies may deduct as expenses the capital costs incurred in:

• Building access roads.

• Port facilities.
• Provision of housing and amenities for employees.
• Provision of structural improvements for the processing of timber.

The total cost is deductible over either the number of years the infrastructure is expected to
be used or 15 years, whichever is the lesser. The annual deduction is calculated by dividing
the un-deducted balance of qualifying capital expenditure (written down value) at the end of
the year of income by the estimated number of years remaining for the particular asset, or 15,
whichever is the lesser.

Timber companies which re-afforest logged areas are allowed to deduction for the full cost of
re-afforestation in the years in which the expenditure is incurred, as well as indefinite carry
forward of losses.

Example

A timber company incurred allowable capital expenditure of 3 million kina on infrastructure

in a timber project. The infrastructure is expected to last for 16 years.

Tax deductions in respect to this expenditure for the first three years would be calculated as
follows:

Year Remaining Life of infrastructure Tax Deductions

1 16 3,000 / 15 = 200,000
2 15 2,800,000 / 15 = 186,667
3 14 2,613,333 / 14 = 186,667

Tax Incentives for Manufacturers

Manufacturing Export Exemption – Pre 1 January 2015

Prior to the 2012 Budget, income derived from the export sale of certain new manufactured
goods was exempt from income tax. However, as PNG is a member of the World Trade
Organisation it is bound by a wide range of international obligations, including the
requirement not to subsidise exports in any form.

To ensure PNG meets this obligation the 2012 Budget abolished the manufacturing export
incentive from 1 January 2015 except in respect of goods which qualified for the incentive
prior to 1 January 2015. The following section describes the applicability of the exemption
before it is phased out from 2015.

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Manufacturing Export Exemption – Pre 1 January 2015

Taxpayers who export certain qualifying goods manufactured by them in Papua New Guinea
are entitled to an income tax exemption of 100% of net export income for three years
following the year in which export sales commenced. For the following four years the excess
of export sales over average export sales of the previous three years is exempt. This point
becomes particularly important given the incentive will be phased out from January 2015.

Expenses in relation to exempt export income are not tax deductible.

If deductions in respect of exempt export income cannot be easily distinguished from expenses
relation to non-exempt income, the following formula should be applied to calculate that
amount of deductions not allowable.

Exempt Income
Total allowable deductions x = deductions for exempt income not allowable
Total Income

The exemption also applies to new manufactured products approved by the IRC. The product
should not be subject to either tariff or quota protection without import parity pricing.

Example

A firm began to export furniture in 2005. Its net profit and taxable income were as follows,
over a seven-year period.

Year Net PNG Net Export Net total Operating

Sales Sales Sales Expenses
2005 30m 2m 32m 8m
2006 30m 5m 35m 10m
2007 30m 4m 34m 10m
2008 35m 4.6m 39.6m 12m
2009 40m 4m 44m 15m
2010 50m 4m 54m 18m
2011 50m 5m 55m 18m

Export sales income for three years, following the year in which export sales commenced
(2005) are exempt from tax. In 2009 only increases in export sales income over the average
of the preceding three years are exempt, so there is no exemption. In 2011, for example, the
excess in export sales over average export sales for the preceding three years is:

K5m – (K4.6m + K4m +K4m) / 3 = K5m – K4.2m = K800,000

This amount – K800,000 – is exempt from tax. Therefore, just K4.2m is taxable.

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Expenses in relation to exempt income are not allowable. Operating expenses in relation to
exempt export income must therefore be excluded from total expenses. We assume in this
example that such expenses cannot be easily distinguished from other expenses, so the
formula given earlier is applied to calculate export expenses. Thus I 2006, export expenses
will be:

10m x 5m / 35m = 1.43m.

This figure must be subtracted from total expenses of K10m to calculate allowable expenses.
The chart

Year Net PNG Net Net total Operating Allowable Taxable

Sales Export sales Expenses deductions income
Sales
2005 30m 2m 30m 8m 7.5m 22.5m
2006 30m 5m 30m 10m 8.57m 21.43m
2007 30m 4m 30m 10m 8.82m 21.18m
2008 35m 4.6m 35m 12m 10.61m 24.39m
2009 40m 4m 44m 15m 15m 29m
2010 50m 4m 54m 18m 18m 36m
2011 50m 5m 54.2m 18m 17.74m 36.46m

Wages Subsidy for Manufacturers

Companies manufacturing new products may receive a taxable wages subsidy payment for up
to 5 years.

The subsidy is based on a percentage of the relevant minimum wage for each full-time citizen
employee as follows:

First year of subsidy 40%

Second year of subsidy 30%
Third year of subsidy 20%
Fourth year of subsidy 15%
Fifth year of subsidy 10%

Double deduction for export market development costs (S.72C)

Expenditure on export market development for goods manufactured in Papua New Guinea
qualify for a double deduction. From 1 January 2006 this also applies to expenditure primarily
incurred for the purpose of seeking opportunities or creating and increasing demand for the
development of tourism within PNG. The types of expenditure which qualify include
overseas publicity and advertising, market research, tender preparation, samples, trade
advertising, overseas sales office expenses, and certain travel costs. It is not available for the
sale of unprocessed primary commodities or for the costs. It is not available for the sale, of
unprocessed primary commodities or for the marketing of services, so the tourism industry
does not benefit from this incentive.

The tax savings from the allowance may not exceed 75% of the total expenditure actually
incurred.

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Import duty drawback

Duty drawback is a rebate paid to exporting manufacturers when they export goods, equal to
the amount of duty already paid on the raw materials. It is offered so that locally manufactured
goods can compete effectively in overseas markets. Requests for the consideration of duty
drawback must include a detailed description of the manufacturing process involved. Once
approved (by Department of Finance and Planning) a drawback notice is then issued. When
goods subject to drawback have been exported, under proper supervision by IRC, drawback
will be paid once the appropriate documentary evidence has been given to the IRC.

Tax Credits for the provision of banking services (S.219D)

A tax credit is available, subject to prescribed limits, for expenditure incurred in providing
basic banking services, which may include the provision of ATM and EFTPOS facilities, in
areas prescribed as being moderately or inadequately supplied with banking facilities. Any
unused credits may be carried forward.

The term ‘‘basic banking services’’ means the provision of a basic banking product which has
the following characteristics:

(a) the customer is able to make deposits into, or withdrawals from, the account,

(b) the customer is charged no more that K1 per transaction for a deposit or withdrawal,

(c) the customer has access to electronic banking through EFTPOS or ATM machines,

(d) there is no minimum account balance required,

(e) there are no other restrictions imposed on the account.

As there is a strong public policy benefit in the establishment of banking services in rural
areas the concession for the roll-out of rural banking services has been extended until 31
December 2017.

Prior to 1 January 2012 the K1 per transaction requirement instead required the provision of
52 free transactions per year. The change to the requirements from 1 January 2012 recognises
the banking products currently provided and the high cost of providing rural services.

Tax Cases

Principles of Repairs

According to the Shorter Oxford Dictionary a ‘‘repair’’ is the act of restoring to a sound or
unimpaired condition. The process by which this is accomplished, specifically, the restoration
of some material thing or structure by the renewal of decayed or worn out parts, by refixing
what has become lost or detached’’.

The main problem in the area of repairs concerns whether or not expenditure on a repair is of
a capital or revenue nature. In essence, it appears that the difference is that between
reconstruction of an entity or substantially the whole of the subject matter, and renewal or
replacement of subsidiary parts of the whole [Lurcott v Wakely & Wheeler (1911) 1KB 905].

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Essentially where what is done goes beyond being a repair and amounts to an improvement,
there will be no deduction allowed [FCT v Western Suburbs Cinemas Ltd (1952) 86 CLR
102].

As Windeyer J said in W Thomas and Co Limited v FCT (1965) 14 ATD 78, ‘‘repair involves
a restoration of a thing to a condition it formally had without changing its character. But in
the case of a thing considered from the point of view of its use as distinction from its
appearance, it is restoration of efficiency and function rather than repetition of form or
material that is significant. Whether or not work done upon a thing is aptly described as a
repair of that thing is thus a question of fact and degree’’.

Determining what the entirety is a question of fact in each case. In Lindsay v FCT (1961) 106
CLR 377 the reconstructing and lengthening of a slipway was regarded as capital, while in
Rhodesian Railways Ltd v ITC (Beck) (1963) AC368, the replacement of a substantial
proportion of sleepers and rails in a railway was regarded as repairs.

Furthermore, expenditure which results in an improvement to property will be regarded as

being of a capital nature and non-deductible. Thus, in Western Suburbs Cinemas v FCT
expenditure on replacing a theatre ceiling with a new and better ceiling was regarded as an
improvement to a fixed capital asset and non-deductible.

Papua New Guinea Income Tax Review Tribunal [Case 34(86)].

The taxpayer owned a block of flats. The walls of six of the flats began to crack, apparently
because the foundations subsided when the ground below shrank in a drought. The taxpayer
spent a lot of money having the foundations underpinned and the walls patched, rendered and
restored. The IRC disallowed a deduction under S.72 for the costs of underpinning, on the
ground that it effected an addition or improvement to the building rather than a repair.

On a reference to the Income Tax Tribunal it was contended for the IRC that the underpinning
work was an addition or improvement to the building because it reinforced the existing
foundations which were not constructed in a manner sufficient to withstand movement in the
ground below. It was contended for the taxpayers that all that was to restore the foundations
to their original position and condition.

HELD – Objections allowed. The result of the underpinning work was that the foundations
were strengthened, but it was an oversimplification to conclude from that, that the work went
beyond mere repair of the deterioration that had occurred to the building. The distinction is
between, on the one hand, restoration and, on the other, reconstruction of the whole or a
substantial part of the entirety of the building. The underpinning although extensive and
costly, did no more than restore the foundations of that they could perform the functions they
were designed to perform. It did not change the nature of the asset. Even if its purpose was
to prevent a repetition of subsidence that did not negate the character of the repair.

FCT v Western Suburbs Cinemas Ltd – (1952) 5 AITR 300

High Court of Australia

The taxpayer company owned and operated several motion picture theatres. The celotex
ceiling in one of its theatres was in a state of disrepair and the taxpayer’s architect was of the
view that repair of the ceiling was impracticable. Consequently, a new fibro ceiling was
installed at a cost of more than £3000. The taxpayer claimed as a deduction under S.53 (S.72

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in PNG) of the Assessment Act, the sum of £603 being: (1) the estimated cost of repair of the
ceiling had it chosen to repair it; or (2) the estimated cost of work done in replacing the ceiling,
which work would have been equally necessary if repair only had been carried out. The
Commissioner appealed against a Board of Review decision upholding the taxpayer’s claim.

Held - The appeal was upheld. The work done was in the nature of an improvement an
improvement and not merely a repair. As such, it was expenditure of a capital nature and not
deductible. Furthermore, the cost of improvements cannot be apportioned so as to attribute
part to the cost of notional repairs which would have been necessary if the improvements had
not been made.

Initial Repairs

A second type of non-deductible capital expenditure is expenditure in property soon after its
acquisition. ‘‘Initial repairs’’, incurred in circumstances where the item subject to repair is
acquired in a condition that requires repair prior to use may well be considered as capital on
the basis that it forms part of the acquisition and utilisation cost of the asset [Law Shipping
Co v IRC]. On the other hand, there is UK authority that if it can be shown that the initial
repairs are basically revenue in nature, that the capital cost of the asset has not been reduced
by the amount of the charge, and the amount of repairs has not been increased by the delay,
then the repairs will be on revenue account [Odeon Theatres v Jones (1972) 1 AER 681]. It
is uncertain whether these rules would be applied in PNG.

Law Shipping Co Ltd V Inland Revenue Commissioners – (1924) 12 TC 621

In 1916 the taxpayer company purchased a ship ready to sail with freight booked. At the time
of purchase the periodical Lloyd’s survey was overdue but an exemption was obtained to
enable the vessel to complete its commitments. Upon return from the voyage the survey was
undertaken, and the taxpayer had to spend approximately £50,000 on repairs to bring the
vessel up to the standard required. It claimed that amount as an allowable deduction.

Held: The sum was not deductible because it was an outgoing of a capital nature. As the
taxpayer purchased a ship which was already in need of extensive repair, the cost of those
repairs must be regarded as part of the purchase price. This was so because the purchase price
would have allowed for the state of disrepair.

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Papua New Guinea Income Tax Review Tribunal (Case 12[82]).

A taxpayer purchased house property which he rented out and within the first twelve months
carried out certain repairs. In his tax return for the year in question, he claimed a deduction
under S.72(1) for repair costs for the hot water service, washing machine and door locks.
These claims, and other claims, were disallowed by the IRC, and the taxpayer requested the
matter be referred to the Income Tax Review Tribunal.

Held: The expense incurred in repairing the hot water service only six months after acquiring
the property was not attributable to the derivation of rent by the taxpayer. This expenditure
was attributable to the use of the property by the former owner and was of a capital nature.
The repairs to the washing machine and locks arose during the period of rent derivation and
were attributable to that rent. The expenditure was not of a capital nature and was an allowable
deduction under Section 72(I).

Property Purchased in State of Disrepair

W. Thomas and Co. Limited v FC of T (1931) 14 ATD 8. It is generally immaterial that the
defects which were the subject of subsequent repairs were unknown at the time of purchase.

Particular factors which can influence the conclusion of fact that the asset was in need of
repair at the date of purchase would include:

a) The purchase price was substantially less than it otherwise would have been.

b) The asset was not in a position to be used or properly used in its intended function; and

c) Generally accepted accounting principles would not have treated the expenditure as an
expense, but rather would have capitalised the expenditure as part of the cost of the
assets.

If an outright deduction is not available for an initial repair, then it is likely to be acceptable
to treat is as capitalised into the asset to which it refers and then it comes depreciable for tax
purposes at the same rate as the original asset.

Principles of Bad Debts

Pont v FCT – (1970) 119 CLR 453; I ATR 577; 70 ACT 4021

Prior to 25 May 1964 the taxpayer was owed £70,734 by a company which he controlled. In
December 1963 the company went into liquidation and on 25 May 1964 the taxpayer, the
company and the provisional liquidator executed a deed by which the company was released
from its debt. At some date between September 1964 and April 1965, the taxpayer’s
accountants made an entry in the taxpayer’s books, showing the date 30 June 1964, to the
effect that the company’s indebtedness to the taxpayer was a bad debt and written off as
irrecoverable. Consequently, in his return for the year ended 30 June 1964 the taxpayer
soughs a deduction under Section 63 of the Assessment Act for the bad debt. The
Commissioner rejected the claim, arguing that Section 63 had not been complied with. The
taxpayer appealed.

Held: The appeal was dismissed. A deduction for bad debts under Section 63 is only
allowable if the writing – off actually takes place in the year of income in which the deduction

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is sough. The section is not complied with if the debt is not written off during the year of
income but at some later date.

Principles of ‘‘Same Business Test’’

A leading case on Section 101G is the Australian High court decision in Avondale Motor
(Parts Limited v F.C OF t. 71 A.T.C. 4104. The taxpayer in question (under a prior name)
sold motor parts and spares for certain vehicle manufacturers for which it held franchises.
The taxpayer, after suffering losses for some time, closed all of its four premises, paid off its
employees and disposed of all its stock and plant. The company was then sold after which it
changed its name to Avondale Motor (Parts) Limited.

Gibbs, J., held that the company was not carrying on any business before the sale and
therefore, could not be said to be carrying on the same business after the change, so that no
deduction was allowed under the Australian equivalent of Section 101G. However, Gibbs, J.,
then went on to consider whether the company would have passed the Australian equivalent
of Section 101G had it been carrying on its prior business immediately before the change in
shareholding. Gibbs, J., found that the company now carried on the same kind of business
under a different name, at different places, with different directors and employees, with stock
and plant and in conjunction with a motor dealer having different franchises. The test in the
Australian equivalent of Section 101G, in the view of Gibbs, J., required the same business to
be carried on rather than the same kind of business. This test was not satisfied on these facts.

Section 101G contains anti-avoidance provisions where, prior to a disqualifying change in

ownership, a company commences to carry on a business for the purposes of satisfying the
same business test.

Recent cases have removed some of the restrictions formerly imposed by earlier decisions
which basically required that the business be identical both before and after the change and
that any variation would disqualify the company from claiming losses brought forward.
Companies may now vary their operations to a limited extent and still satisfy S.101G. Great
care must be taken in this area as much will depend on how the business is characterised, both
before and after the change in ownership. (See J Hammond investments v FC and AGC
(Advances) Ltd v FCT 77 ACT 4311 and, more recently, Case Y 45 91 ACT 426). Reference
should also be made to the Australian Commissioner’s rulings IT 97, IT 118Y, and IT 2399.

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Self-Assessment Exercises

Question 1

The owner of a dance hall, on ascertaining that a portion of the ceiling of the hall was in need
of repairs, decided to replace the whole of the ceiling with a different but better material. The
new ceiling, in addition to enhancing the appearance of the hall, improved the acoustics. The
total cost of the material and of erecting the new ceiling was K240,000. It was estimated that
the cost of repairing the ceiling would have been K150,000.

With reference to Section 72, discuss the amount, if any, allowable as a deduction for income
tax purposes.

Question 2

Tom Scavenger buys a large second-hand engine-driven item of plant for use in his
manufacturing operations for a cost of K7000. However, when he tries to use it he discovers
that it won’t operate because two large cylinders in the engine are broken. He has the broken
cylinders repaired at a cost of K500.

Is this expenditure deductible?

Question 3

Are any of the following allowable deductions? If so, how much and under which section of
the Tax Act?

a) The replacement at a cost of K9863 of the motor in a forklift truck owned by a

manufacturing company.

b) Modifications cost of K25,692 to an industrial shed owned by a heavy engineering

repair business enabling the installation and operation of an overhead heavy-lift crane.

Question 4

Discuss whether the following are allowable deductions under S.68(I).

a) Legal expenses incurred by a company opposing a petition for winding up.

b) Legal expenses incurred for the services of a solicitor in respect of a number of matters,
including conveyancing, discharge of a mortgage, and general legal advice relating to a
client’s business operations. (The solicitor’s account does not separate the costs of the
various matters.)

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Question 5

a. A company produced the following results:

2000 Loss K140,000

2001 Loss 120,000
2002 Loss 80,000
2003 Profit 240,000
2004 Profit 220,000

Draw up a table to show the treatment of losses for tax purposes.

b. Another company produced the following results:

2000 Loss K125,000

2001 Profit 90,000
2002 Loss 100,000
2003 Profit 80,000

The business also earned exempt income of K25,000 in each of these years. Show the
treatment of losses for tax purposes.

Question 6

A fishing company with a small fishing fleet involved in tuna fishing began operations in
2000. It had accumulated losses of K700,000 for tax purposes at the end of 2004. In 2005 it
earned a net income of K300,000. In early 2006 it sold out to another company that year. In
2007 it established a small fishing cannery to process its catch. In that year its net income
was K250,000.

Calculate taxable income for 2005, 2006 and 2007.

Question 7

State in your opinion whether or not the following expenditure is tax deductible:

a. Repainting the ceiling of a premises.

b. Inserting two windows in the back of a business premises.
c. Repairs to a building which has just been purchased.
d. Fixing shop fittings damaged during a break-in.
e. Erecting steel poles to replace wooden poles for a fence around a coffee plantation.

Question 8

A firm in 2003 issued debenture stock of K5 million, repayable in ten years. The costs for
issuing this stock, which included the issue of a prospectus, stamp duties, legal fees and
underwriter’s fees, amounted to K40,000 all incurred on 30 June 2003. Calculate allowable
deduction in respect of this expenditure for the year of income 2003.

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Question 9

A property business on 1 July 1999 borrowed K500,000 to construct residential rental

property. Loan establishment costs amounted to 5,000. The terms of the loan were 10% flat
rate, repayable over 6 years. The property was built by February and rental income received
from that time.

Calculate allowable deductions in respect of the property loan in 1999.

Question 10

A person earning a salary of K50,000 per annum has also rental property which during the
year of income earned a steady flow of income of K450 per week, all of which was received
in cash. The taxpayer paid interest on a loan to purchase the property amounting to K4,500.
Other allowable expenses relating to the property amounted to K4,800. Calculate tax payable
on rental income received.

Question 11

Refer to the previous question. In the following year the taxpayer earned the same salary.
The rental property was untenanted for six months because the house was in need of
substantial repairs, and the time taken to carry out the repairs. The cost of repairs, including
new kitchen fixtures costing K2,000, plus other allowable expenses amounted to K12,500.
Interested payable on the outstanding loan amounted to K3,350. Weekly rental income
remained the same as the previous year.

Calculate tax payable.

Question 12

A coffee plantation issued the following trading figures and expenses for a certain year of
income:

Trading Income 2,200,000

Wages 450,000
Insecticides 35,000
Clearing of land 30,000
Seedlings 25,000
Equipment 280,000

Calculate taxable income.

Question 13

A coffee plantation business incurs development costs of K1.2 million. Tax deductions
permitted in respect of this expenditure are transferred to the shareholders of the company at
the rate of 20 toea per share held. One shareholder with 10,500 shares has a salary income of
K14,000 per annum. He has no dependants.

Calculate his tax rebate entitlement.

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Question 14

A business involved in primary production and other activities had the following trading
results:

Year Primary Production Other Business Activities

1 25m (loss) 18m (profit)
Exempt income: 2m

2 20m (loss) 2m (loss)

Exempt income: 2m

3 15m (profit) 10m (profit)

Exempt income: 2m

Calculate taxable income for each year and accumulated losses carried forward if any.

Question 15

A timber company with a 25-year lease incurred development expenditure of K1.5 million in
1999 in constructing housing (with an expected life of 12 years) for employees. Calculate
deductible tax allowances for the first three years of the project in respect of the above
expenditure.

Question 16

a. A manufacturing firm has been exporting goods for a number of years which qualify for
tax exemptions on profits during the first years of operations. The firm is also a
substantial supplier of the same goods within Papua New Guinea. In the third year, its
net sales income from exporting goods is K2.5 million. Net sales in the domestic market
are K1.8 million. Total expenses in respect of the above activities total K850,000.
Calculate taxable income for the year. (Assume that expenses in relation to export
income are indistinguishable from other expenses).

b. In the sixth year of exporting, the firm’s net sales income from exporting goods is K4m.
Average export income for the preceding three years amounted to K3.8m. Net domestic
sales in the same year amounted to K2.5m. Total operating expenses amounted to
K1.2m.

Calculate taxable income for the year.

Question 17

A Papua New Guinea company begins producing a new product in 1995. It has obtained a
New Product Manufacturing Certificate from the IRC in order to qualify for a government
subsidy. It employs ten workers, paying them K500 per fortnight. The minimum wage
payable in each case was K280. Calculate the subsidy it receives each year from 1995 to
1999. Assume that minimum wages have been adjusted upwards (CPI) by 5% each year.

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Question 18

An Australian property development company (‘‘Aust Co’’) wishes to develop property in

Port Moresby. It establishes a wholly owned subsidiary in PNG (‘‘PNG Co’’) which will be
responsible for acquiring land and constructing the building in Port Moresby. PNG Co’s only
means of financing is to issue shares of K50m to Aust Co and in addition borrow k200m from
Aust Co to finance the PNG Co’s first property development. Interest on the loan is calculated
as being K5m. To what extent is this interest expense on the loan from Aust Co deductible
for PNG Co.?

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Answers to Self-Assessment Exercises

Question 1

Deductibility here depends upon whether the taxpayer has ‘‘repaired’’ the ceiling, whether
expenses have been ‘‘incurred’’, and whether those expenses are of a capital nature. The
decision in FCT v Western Suburbs Cinemas Ltd 1952 AITR 300 is of assistance in
addressing these issues.

To determine whether the taxpayer has repaired the ceiling, consideration must be had as to
whether worn out parts have been replaced, or defects have been remedied, in something less
than the entirely. If the taxpayer has merely repaired a part of the entirety, an entitlement to
a deduction will arise under Section 72. However, if the entirely is replaced, or some
improvement is made to it, the measures have gone beyond ‘‘
repair’’ in terms of Section 72.

The use of different materials does not of itself imply an improvement. ‘‘It is restoration of
efficiency in function rather than exact repetition of form or material that is significant’’: W
Thomas & Co Ltd v FCT (1965) 9 AITR 710. It must be considered whether an asset or
advantage of a different kind has been brought into existence as a result of what has been
done. Here it would appear that the better acoustics means there has been an improvement.

Another issue in Western Suburbs Cinemas was that Section 72 does not provide a deduction
for notional repairs. It requires that the cost of repairs has actually been incurred. In this
question the amount incurred was K240,000. Its character will depend upon the nature of the
purpose for which it was incurred. If the total K240,000 was of a capital nature, then so too
is every part of it. It is not possible to claim a deduction for the k150,000 cost which would
have been incurred by different activities.

Question 2

The expenditure would not be deductible under Section 72 as a repair because it falls within
the category of being an initial repair, meaning it would be categorised as expenditure of a
capital nature. For the same reasons, namely that it is capital expenditure, it would not be
deductible under Section 68.

The reason that it is an initial repair is that it was necessary to put the item of plant into a
condition suitable for the use for which it was intended. In other words, it was not merely
restoring it to its original state and condition as when acquired by the taxpayer, in order to
make it suitable for the use the taxpayer intended for the item of plant.

However, even though an outright deduction would not be available for the expenditure, it
could be added to the cost of the item of plant and depreciated under Section 73. Hence a
deduction over time could be obtained.

Page | 92
Question 3

a) Section 72 provides a deduction for repairs (i.e. replacement of worn out parts). If
replacement is of an entirety, no deduction is available under Section 72. As the motor
is only part of the forklift, a repair has been affected. Provided the motor is similar to
the one it replaced; no improvement will be involved. Improvement is involved where
there is increased efficiency of function, not simply a replacement of new parts of old
parts.

b) In this case an asset or advantage comes into existence. No deduction is available under
Section 72 as either the taxpayer has gone beyond mere repair or the repairs are of a
capital nature. A deduction may be allowed for depreciation under Section 73 if the
modifications are part and parcel of the crane. If they are merely a housing for the crane
they are not plant and Section 73 deduction is available.

Question 4

a) The issue is whether the expenditure relates to the structure and income earning capacity
of the business or merely its operation. See FCT v Snowden & Wilson Ltd (1958) 7
AITR 308, Ward & Co of T (NZ) (1923) AC 145 and PBL Marketing Ltd v FCT (1985)
16 ATR 679. It appears that if the outcome of a case would result in extinction of profit
yielding capacity, as appears to be the situation here. Then the expense is regarded as
capital. However, if the case has more to do with the process of operating the business
then the expense is regarded as revenue in nature.

b) Before any answers can be given, more information is required to be known. For
instance, what property was transferred by the conveyance? What was the property to
be used for? Was the borrowed money used for income producing purposes?

For some items, if separately billed, would be deductible and other items, if separately
billed, would not be deductible the problem of dealing with an undissected account
arises. Can such an account be divided, apportioned or split in some fashion, o must its
predominant character be determined? Ask also whether it makes any difference if the
solicitor is on a retainer to perform legal work.

Question 5

a.
Year Profit Loss Recouped Year Loss c/f
2000 140,000 140,000
2001 120,000 260,000
2002 80,000 340,000
2003 240,000 140,000 2000
100,000 2001 100,000
2004 220,000 20,000 2001
80,000 2002 120,000

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b. 2000: Loss K125,000
Less exempt income 25,000
Loss carried forward 100,000

2001: Profit 90,000

Plus exempt income 25,000
115,000
Less loss carried forward 100,000
Taxable income 15,000

2002: Loss 100,000

Less exempt income 25,000
Loss carried forward 75,000

2003: Profit 80,000

Plus exempt income 25,000
105,000
Less loss carried forward 75,000
Taxable income 30,000

Question 6

2005 : Taxable income – Nil – because of losses carried forward.

2006 : Taxable income – Nil. New company carries out same activity, so losses may be
carried forward.

2007 : Taxable income – K250,00. Accumulated losses may not be used because activities
of the new company different from when the losses were incurred. In order for the
new owners of the company to benefit fully from the accumulated losses, it would
be better for them not to introduce new activities until previous years losses were
used up.

Question 7

a. Deductible
b. Not deductible
c. Not deductible
d. Deductible
e. Deductible
f. Not deductible

Question 8

Allowable deductions in respect of borrowing costs would be: (K40,000/5)*6/12 = K4,000 in

year ended 31 December 2003.

Page | 94
Question 9

The interest payable in respect of the loan would not be allowable in 1999 because no income
had been earned by that time. This interest would be capitalised, becoming part of the initial
capital costs, for which depreciation can be claimed. Part of the borrowing costs could be
claimed in 1999, calculated as follows: 5,000 / 5 = K1,000.

Question 10

Non-salary income: Rental income 23,400

Less interest 4,500
Less other expenses 4,800 9,300
14,100
Gross tax on total income of 64,000 19.335
Less gross tax on salary income of 50,000 14,400
Tax on non-salary income 4,935

Question 11

Rental income 11,700

Less interest 3,300
Less other expenses 10,500 13,850
Non-salary loss 2,150
(New kitchen fixtures non-allowable, but depreciation allowance can be claimed)
Salary income K50,000
Loss on non-salary income 2,150
Taxation income 47,850

Gross tax payable on 50,000 14,400

Gross tax payable on 47,850 13,647
Tax rebate due 753

Question 12

The coffee plantation, being a primary industry because would be allowed an outright
allowance for all of the expenditure incurred. Taxable income wold K1, 380.00

Question 13

Allowable deduction : 10,500 x .20 = K2,100

Rebate : (2,100 x .25) = K 525

Page | 95
Question 14

Year 1 Primary industry 25m (loss)

Less profit from 18m
Overall loss 7m
Less exempt income 2m
Loss carried forward 5m

Year 2 Primary industry 20m (loss)

Other activities 2m (loss)
Overall loss 22m
Less exempt income 2m
Loss carried forward 20m Accumulated
losses 25m

Year 3 Primary industry 15m

Other activities 10m
Overall profit 25m
Less losses carried forward 25m
Less exempt income 2m 23m
Taxable income 2m
Accumulated losses carried forward Nil

Question 15

Year 1 1,500,000 / 12 = 125,000

Undeducted balance 1,375,000
Year 2 1,375,000 / 11 = 125,000
Undeducted balance 1,250,000
Year 3 1,250,000 / 10 = 125,000

Question 16

a. Calculation of expenses in relation to exempt income:

.85m x 2.5m / 4.3m = K494,186

Allowable expenses: 850,000 - K494,186 = K355,814

Taxable income: 1,800,000 – 355,814 = K1,444,186 (Export income exempt)

b. Assessable export income is 3.8m, not 4m, because the excess over the average for the
previous three years (.2m) is tax free.

Calculation of expenses relating to exempt income (not allowable):

1.2 x .2/6.5 = .037

Page | 96
Question 17

1995 : 2,800 x 40% = 1,120

1996 : 2,800 + 5% = 2,940 x 30% = 882
1997 : 2,940 + 5% = 3,087 x 20% = 617
1998 : 3,087 + 5% = 3,241 x 15% = 486

Question 18

In order to determine how much of the K5m is deductible for PNG tax purposes, one must
use the following formula:

T1 x 2E
D

Where: TI = 5m E = 50m D = 20

5m x 100m
= 2.5 m
200m

K2.5m of the K5m interest is deductible.

Page | 97
Self-Assessment Test

Question 1

Mr C de Mille of Haus Piksa Ltd comes to see you about the tax treatment of the cost of some work
he is doing to his movie theatre. He is replacing some tiles in his celling with the nearest modern
equivalent because he can no longer get the original type. They match in quite nicely with the old
ones, are cheaper, offer better insulation and he considers them to be a major improvement over the
old ones. He will continually replace files as and when he can afford it. Because the tiles are such an
improvement, he assumes they are not deductible. You tell him:

a) He is right, the tiles are a clear improvement and improvements are a capital expense because
they are not incurred in returning the asset to its original condition.

b) He is wrong, the cost of the tiles is deductible because he is using the nearest modern equivalent
as the old tiles are no longer available.

c) He is right because he is replacing an asset and a replacement is a capital expense.

d) He is wrong, the tiles are deductible because he is completing the work as he derives income
from the theatre and that means they are incurred in the course of carrying on his business and
deductible.

Question 2

You work doing the accounting and tax work for a restaurant has become the flavour of the month in
Port Moresby and is enjoying tremendous success. Times were not always so good and the company
running the restaurant did make losses in the past and is hopeful of recovering those losses. The
current owners purchased the company when the old owners become alarmed at the size of the losses
they were incurring and the prospects for the business and sold out. The boss now comes to you and
says he is sick of the hours involved in running a restaurant and wants to change the business into an
industrial catering business which will give him much better hours.

You tell him:

a) This is a fine idea and the company will still be able to claim its losses because they have been
incurred less than 20 years ago.

b) This is a fine idea, but the company will now be able to claim its losses because it needs to pass
a continuity of ownership or, failing that, a continuity of business test, and it hasn’t done that.

c) This is a fine idea and the company will still be able to claim its losses because the company
first passed the continuity of business test (when he bought the restaurant company) and then
the continuity of ownership test (after he changes the business). Since he has at all times passed
one of the two tests, he will be able to claim his losses.

d) This is a fine idea, but the company will not be able to claim its losses because they need to have
been incurred by a primary production company and selling food is not primary production.

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Question 3

A company incurs legal expenses during the year for advice concerning all of the following:

1. Purchasing a new warehouse

2. Trying to prevent a foreign competitor setting up in Papua New Guinea
3. Chasing debts owed to it by its customers
4. Borrowing money for income producing purposes

A tax deduction is available (even if not in the current year but at some time in the future) for:

a) 1 and 4

b) 2 and 4

c) 3 and 4

d) 1 and 3

Question 4

A tax deduction is available to a company in the year of income for the following:

a) Repairs, unrealised exchange losses and entertainment expenses

b) Security expenses of staff, provision of long service leave for staff and bad debts written off
during the audit of the previous years’ accounts.

c) Loss on sale of property bought for investment purposes, electricity expenses incurred in respect
of staff accommodation and provision of leisure facilities.

d) None of the above.

Question 5

A deduction is available to a company for expenditure incurred on repairs if:

a) It was apparent the item being repaired required those repairs at time of purchase.

b) The repairs constituted an improvement or addition.

c) The repairs restored the asset to its original condition.

d) None of the above.

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Question 6

A company is entitled to a double tax deduction for:

a) Salaries paid to staff while they are attending a full-time professional training course.

b) Wages paid to registered apprentices.

c) Salaries of full-time trainers not engaged in the income earning activities of the company.

d) If deductions exceed assessable income and exempt income.

Question 7

Under Section 101 losses of previous years may be carried forward:

a) If incurred in the last 20 years.

b) Indefinitely.

c) If deductions exceed assessable income.

d) If deductions exceed assessable income and exempt income.

Question 8

A resident company in January 1996 borrowed1 Aus $3 million to be repaid at the end of six years.
The rate of exchange throughout 1996 was 1 kina = 1 Aus $. Interest was fixed at 10% during the
duration of the loan. Establishment and other costs associated with raising the loan amounted to
K80,000.

At the end of the year of income 2002, when this loan was repaid, the rate of exchange was 1 Kina =
Aus$ 48.

Allowable deductions for 1996 would be:

a) K316,000

b) K380,000

c) K3,316,000

d) K3,380,000

Question 9

Refer to question 8. Assessable income/ allowable deduction in respect of the foreign exchange
gain/loss when the loan was repaid in 2002 would be

a) Assessable income of K3,250,000 (forex gain).

b) Allowable deduction of K3,250,000 (forex loss).

c) Assessable income of K6,250,000 (forex loss).

d) Allowable deduction of K6,250,000 (forex loss).

Page | 100
Question 10

PNG Company (‘‘PNG Co’’) borrows K400m from a related company, resident in Australia. PNG
Co has equity of k15m and the interest charge on the loan is calculated as being K9m. Which of these
is correct:

a) K7,987,500 is deductible for tax purposes.

b) K675,5000 is deductible for tax purposes.

c) No amount of the interest is deductible.

d) K1,012,500 is deductible for tax purposes.

e) K1,275,000 is deductible for tax purposes.

Page | 101
Answers: Self-Assessment Test
Question 1

a) is incorrect. While improvements are a capital expense the issue is whether replacing a few tiles is
an improvement of the whole asset, compared to its original condition, or a repair. A repair improves
the condition of an asset compared with the state that asset was in just before repair work was carried
out but that does not make such a repair an improvement for these purposes.

a) is correct. He is repairing the whole ceiling with the nearest modern equivalent materials that he
can find, and the tax law is not so harsh as to insist he use exactly the same materials if those material
are not available. He is not replacing the whole ceiling at once, so it cannot be said that he is replacing
an asset.

a) is incorrect because the tiles would not be considered an asset in their own right whereas the ceiling
and possibly even the ceiling would be. D) Is incorrect. Whether or not the expense is incurred in
gaining or producing assessable income is not the point at issue. The point is whether that expense is
capital or not and thereby excluded from deduction under Section 68.

Question 2

a) is incorrect because this condition is not the only one that needs to be satisfied for losses to be
carried forward for tax purposes. c) Is incorrect because it is. One of the two tests need to be passed
at all times between when the losses were incurred and when they are claimed, and this means the
same test for that period. This is the reason b) Is correct. d) is just plain wrong.

Question 3

c) is correct because legal expenses incurred in collecting monies owed to the company are considered
revenue expenses deductible and legal expenses incurred in borrowing money are treated as borrowing
expenses and therefore deductible over the life of the loan or 5 years, whichever is less. a), b) and d)
are incorrect because they each draw from items 1, and 2, that are given, both of which are capital and
non-deductible expenses.

Question 4

c) is correct as can be seen from the discussion of the various forms of accelerated depreciation in the
unit.

Question 5

d) is true because none of the examples have all three examples being tax deductible, a) Has an
example of expenditure which is tax deductible, namely repairs, but the others are not.

Question 6

c) is correct because it falls squarely within the definition of what constitutes a repair under the case
law. The first two examples are of capital expenditure and the last is incorrect because there is a
correct example of a repair.

Question 7

d) is correct as all three items qualify under Section 72(4) of the Act for double deduction.

Page | 102
Question 8

d) is the correct answer. If deductions exceed assessable income, then exempt income must be
included before a loss can be claimed. Although losses may, from 2003, be carried forward for twenty
years, the seven-year limit applies for losses incurred up to 2003. This means that losses incurred
before 1994 may not be carried forward. So, a) Is not correct.

Question 9

a) is the correct answer. Deduction for 1996 calculated as follows:

Interest payments K300,000

Borrowing costs (80,000 / 5) 16,000
Allowable deductions 316,000

Question 10

Loan repayment in 2002 in kina terms would be 3 million / .48 = K6,250,000. K3,250,000 represents
the foreign exchange loss which would be tax deductible.

b) is therefore correct.

Question 11

Is the correct answer. K675,500 is deductible for tax purposes by calculating:

9m x 30m
= 675,000 m
400m

Page | 103
5 SPECIFIC DEDUCTIONS – DEPRECIATION

Leaning Objections

After you have successfully completed the work in this unit you should be able to:

• Identify the methods for calculating depreciation for tax purposes.

• Refer to the depreciation rates table to calculate depreciation for tax purposes.

• Consider the most appropriate depreciation methods for tax purposes.

• Apply the rules for ascertaining a table gain (balancing charge) or loss (balancing
deduction) on the disposal of depreciated assets.

• Explain the circumstances for which accelerated depreciation is allowed and how it is
calculated.

• Calculate depreciation for leased assets and assessable income on sales.

• Explain how assets may be pooed for depreciation purposes.

In most cases taxpayers cannot claim an outright deduction for purchasing capital assets.
Instead, an annual depreciation deduction may be claimed. There are various sections within
Division 3 of the Income Tax Act relating to depreciation, which are as follows:

• Meaning of plant Section 73(2).

• Meaning of ‘eligible property’ Section 73(2).
• Meaning of ‘industrial plant’ Section 73(2).
• Choice of depreciation methods Section 74-75.
• Loss on disposal Section 78(1)
• Depreciation recouped Section 78(2).
• Balancing charge Section 78(3).
• Accelerated deductions Section 73(3).

Plant or articles

Depreciation is allowable in respect of assets that are ‘‘plant or articles’’. The Act sets out
items, which are included in plant [section 73 (2)] but contains no definition of the actual
terms ‘‘plant’’ or ‘‘articles’’.

‘‘Plant’’ is defined in the Oxford English dictionary as ‘‘the fixtures, implements, machinery,
apparatus used in carrying on any industrial process…’’

‘‘Plant’’ in its ordinary sense, includes whatever apparatus is used by a businessman for
carrying on his business. This does not include his stock-on-trade that he buys or makes for
sale but all goods and chattels, fixed or moveable, live or dead, which he keeps for permanent
employment in his business.

Page | 104
Depreciation is allowable for the use, exhaustion, wear and tear and obsolescence of plant and
requirement and articles used to produce assessable income. Deductions for depreciation are
allowable in addition to any deductions on account of maintenance and repairs to the asset
concerned.

The IRC has calculated the life of most fixed assets. The depreciation be used by the taxpayer
during the year of income for the purpose of producing assessable income. However, in
addition to those assets actually used to produce income, depreciation is allowed in respect of
assets which are installed ready for use for that purpose and held in reserve by the taxpayer.

What is included in the cost of an asset for depreciation purposes

Cost of plant

The cost of plant is normally the amount that has been paid for the plant. Where plant is
acquired with other asserts, the cost is so much of the overall cost as is reasonably attributable
to the plant.

Pre-trading expenses and buying expenses allowed for depreciation purposes

Expenditure incurred (including interest) in building or obtaining an asset in a year before

assessable income is earned, or the asset is first used for producing assessable income, is
deemed to form part of the costs of the asset for the purposes of calculating depreciation.
Also, certain buying expenses are included as part of the cost. In other words, these initial
expenses are ‘capitalised’. They are treated as part of the capital cost of an asset.

Some of the most common assets on which depreciation allowance is deductible are:

• Plant and machinery.

• Buildings (including buildings used for accommodating employees and their families).
• Ships.
• Motor vehicles.
• Furniture and fittings.
• Office machinery and equipment.
• Professional library for teachers, doctors, engineers and other professional people.
• Cost of putting together tool kit for carpenters, builders, electricians, etc. However,
replacements may be claimed in full.

Effective Life

Section 74(10 (Estimate of effective life) states that in the first calculation of the depreciation
to be allowed in respect of a unit of property, an estimate shall be made by the IRC of the
effective life of the unit assuming that it is maintained in reasonably good order and condition,
and the annual depreciation rate shall be fixed accordingly.

Page | 105
Depreciation Rates

In practice the IRC has calculated the life of most fixed assets and has set out depreciation
rates based on their effective useful lives. A ‘Schedule of rates of annual depreciation
allowable for assessment purposes; appears as a separate part of Papua New Guinea Income
Tax Legislation produced by CCH.

In the case of special type of plant and equipment used under abnormal working conditions,
other rates may be fixed upon application to the IRC. The rates fixed under these conditions
may be either higher or lower than the normal rates.

Obsolescence

Obsolescence refers to depreciation due to normal technological change. If rapid or abnormal

technological change occurs, a taxpayer may change to a shorter estimated useful life if there
is a clear and convincing basis for the redetermination. In other words, a higher depreciation
allowance can be claimed. In this situation the approval of the IRC will be necessary before
increasing the taxation allowance.

Methods of calculating depreciation for tax purposes (S.74 & 75)

There are two methods available to calculate depreciation – the diminishing value (or
‘reducing balance’) method and the prime cost (or ‘straight line’) method.

Prime Cost method: Under this method, depreciation is charged at a fixed rate on the original
cost of the asset throughout its useful life. The amount of depreciation allowance deductible
in each year remains constant throughout the entire life span of the asset,

Diminishing Value method: Under this method, the annual depreciation allowances each
year diminishes, as it is calculated on the written down value of the asset.

Depreciation is pro-rated where an item is purchased or sold during the year. For example, if
an item were purchased 1 October, the depreciation allowance would be three months only
for that year of income. In practice some taxpayers claim either six months or twelve months
on plant items depending on whether they were purchased in the last or first half of the year.

The Income Tax Act states that depreciation allowances calculated under the diminishing
value method ‘shall be one and a half times that used in the prime cost method’. This you
can see when examining the rates of depreciation table in this unit.

The difference between the two methods is a matter of timing of the deductions rather than a
difference in the total depreciation taken. When using the diminishing value method,
depreciation allowances are higher in the earlier years when the asset is most useful and
theoretically contributes more to the earning of assessable income, and is lower in the later
years as the asset becomes older and less efficient.

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Choice of Depreciation Methods

Under Section 75(1), taxpayers have the choice of choosing either the prime cost method or
the diminishing value method of depreciation. Whichever depreciation is used, no greater
deduction than the written down value is allowed, thus ensuring that the total depreciation
allowed in respect of an item does not exceed its cost to the taxpayer.

The diminishing value method applies unless the taxpayer chooses to adopt the prime cost
method. Where a taxpayer chooses to apply the prime cost method, they may make the
election in respect of:

a) All units of property upon which depreciation is claimed or to be claimed (this means
all existing assets, all current year additions and all future additions); or

b) All units of property acquired during the year of income and in future years of income
(this means all current year additions and all future additions).

Where a taxpayer uses the diminishing value method it is possible for a taxpayer to elect to
use the prime cost method without any formal approval from the IRC. However, once a
taxpayer chooses the prime cost method of depreciation, the taxpayer may not change back to
the diminishing value method without the prior approval of the IRC. And although it is
possible to change back again, it would require a very convincing case to be put forward to
be accepted.

Generally, whether a taxpayer decides to use the prime cost or diminishing value method will
depend on the circumstances. However, as the diminishing value method produces the most
depreciation in the early years it is generally preferable to use the diminishing value method
in the early years and then take advantage of the option of switching to the prime cost method
in later years. By commencing with diminishing value and switching to prime cost a taxpayer
is able to maximize their annual depreciation claim. If a taxpayer is starting a new business
and initial losses are expected, then it may be preferable to use he should use the depreciation
method that producers a lower deduction in the early years (i.e. prime cost). If large profits
are expected to be made in the initial years of business then it may be wise to use the
diminishing value method which produces a larger amount of depreciation allowance in the
early years, thus deferring the payment of tax to later years when the annual depreciation
allowance is lower.

Section 75(1A) and Section 82 ensure that you reduce your deduction for depreciation to the
extent that you did not use the plant for the purpose of producing assessable income. These
provisions are more likely to have application to an individual, trust or partnership of
individuals than a company.

Disposal of depreciated assets (S.78)

A ‘balancing adjustment’ will arise when a depreciated asset is disposed of, resulting in an
allowable deduction or assessable income, depending on whether there has been a loss or a
gain. In determining whether there is a loss or gain on disposal, the disposal price will be, in
the case of:

• Sale – selling price less any selling expenses,

Page | 107
• Loss or destruction - amount, if any, received from insurance pay out,

• Sale of assets sold with other assets with no separate values allocated – an amount
determined by the IRC.

Disposal of assets at a loss: When the amount received for an asset (for which depreciation
has been claimed) is less than the written down value at the time of sale, an allowance, known
as a balancing deduction. May be claimed for tax purposes.

Example

A machine costing K10, 000 is sold for K5, 000. The written down value of the machine was
K7, 000. The loss is calculated as follows:

Cost price K10, 000

Accumulated depreciation
(using approved tax rates) 3,000
Written down value 7,000
Sale price 5,000
Loss and Balancing allowance 2,000

The loss of K2, 000 would be an allowable deduction for the business.

Disposal of assets at a profit: when the sale price of an asset exceeds the written down value,
the excess, known as a balancing charge, is treated as assessable income, and therefore subject
to tax.

Example

A machine costing K12, 000 is sold for K11, 000. The written down value at the time of sale
was K9, 000.

Cost price K12, 000

Accumulated depreciation 3,000
Written down value 9,000
Sale price 11,000
Profit (and Balancing charge) 2,000

If an asset is sold for more than it cost, the excess over the cost price is not included in the
balancing charge. It is treated as a capital gain and so is not assessable income.

Page | 108
Example

Assume that the machine in the above example, which cost K12, 000, was sold for K13,
000.

Cost price K12, 000

Accumulated depreciation 3, 000
Written down value 9, 000
Sale price 13, 000
Profit on sale 4, 000
Less: selling price – cost price 1, 000
Assessable balancing charge 3, 000

A balancing charge can be included in assessable income or it can at the option of the taxpayer
be set off against the value of other assets in the following order [S.78(3)]:

• Cost of a replacement asset (up to two years later).

• Cost of other assets purchased.
• Depreciated values, at the beginning of the year of income, of other assets. This is
permitted in the case where no new assets have been purchased in the year in which the
balancing charge arises.

In each case the result would be to reduce the amount of current and future depreciation
claimable by the amount of the balancing charge. However, the taxpayer must make an
election and if not, the balancing charge will be treated as assessable income.

Example

A business purchases a vehicle for K50, 000. It received a trade-in of K15, 000 for another
vehicle, the book value of which was K12, 000. The value of the new vehicle for depreciation
purposes would be:

Cos of new vehicle K50, 000

Less assessable ‘balancing charge; of trade in 3,000
Value for depreciation purposes 47,000

If no replacement asset has been purchased, the business could offset the balance charge by
reducing the depreciated value of other new or existing assets [S.78(3)].

Treatment of balancing charge for business closing down

A taxpayer (excluding companies) which closes down a business as a result of loss or disposal
of assets may have an assessable balancing charge that it cannot offset against remaining
depreciable assets. In such a case the taxpayer can apply to have its taxable income taxed at
a rate applicable to a notional income. The notional income is:

• Where the taxable income exceeds the balancing charge – taxable income minus 2/3 of
the balancing charge (or the taxpayer’s share of it in the case of a partnership.

• Where the taxable income is less than or equal to the balancing charges, - 1/3 of the
taxable income.
Example 1

Page | 109
X runs a business as a sole trader that is ceasing operations following the disposal of its assets.
His taxable income, which represents the firm’s income, is K200, 000, made up of K140, 000
plus balancing charge of K60, 000 caused by the disposal of depreciable assets resulting in
the firm’s shutdown. The tax payable on the taxable income of K200, 000 is at the average
rate applicable to a notional income of K160, 000 (K200, 000 – 2/3 of K60, 000). (see
personal income tax tables in Ut 6, page 2).

Tax payable on K160, 000 55,210.00

Tax rate payable on notional income of K160, 000 is 34.5% [55,210 / 160,000]
Tax payable on K200, 000 @34.5% K69,000

Example 2

Assume the same situation as in Example 1. Taxable income is K270,000, loss of K30,000
and assessable balancing charges to K300,000, as a result of the sale of the firm’s remaining
assets. Tax payable on taxable income of K270,000 is at the average rate of tax payable on
notional income, of K90,000 (1/3 of K270,000).

Tax payable on K90,000 27,210.00

Tax rate payable on notional income of K90,000 is 30.2% [27,210/60,000]
Tax payable on K270,000 @30.2% K86,400

Accelerated Depreciation (Section 73)

Businesses engaged in manufacturing, communications, transport and storage, financial

intermediation, real estate and renting, agricultural production and operators of hotels and
other short-term accommodation facilities may be allowed accelerated depreciation in the year
of purchase or construction of new assets with a life of over five years. Such assets, for which
accelerated depreciation is allowed, are classified for tax purposes as ‘eligible property’. A
deduction of 20% of the cost is allowed in that year, in addition to the normal depreciation
allowable. Excluded from this concession are plant or articles (other than shipping vessels
and aircraft) which rely on imported petroleum products (including LPG) as its source of
power. It is noted that now the Napa Napa refinery is operational, equipment using this
domestic source of fuel will qualify for accelerated depreciation.

Example

A transport company constructed a new garage building at the cost of K800, 000 completed
on 31 March 2013. The permitted depreciation rate chosen was 2% - prime cost method.

Qualifying Expenditure K800, 000

Depreciation 2% x 9/12 12,000
Written down value 31/12 0X K788, 000

The company would also be entitled to claim an additional depreciation allowance of 20% of
the cost price during the initial year.

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Total depreciation allowances available to the company for 2013 would be:

Ordinary depreciation allowance K12, 000

Add: additional depreciation at 20% of cost price of K800, 000 160, 000
Total depreciation allowance 172, 000
Written down value 31/12/13 628,000

For item items of industrial plant depreciation of up to 100% may be claimed in their year of
purchase. ‘Industrial plant’ in this context means any plant or equipment with a life exceeding
five years not previously operated in Papua New Guinea which is used in a manufacturing
process. It also includes buildings used for the housing of such plant and equipment. The
maximum depreciation that may be claimed is the depreciated value of the industrial plant.
The taxpayer may elect the amount to be claimed in any one year. But it should not exceed
net income of the business. In other words, a tax loss (to be carried forward) may not be
created as a result.

Expenditure on plant or articles used in agricultural production or commercial fishing

activities qualify for a 100% initial depreciation deduction, and any losses created as a result
may be carried forward.

Similarly, expenditure on boats and ships used by scuba diving and/or snorkelling tour
operators (and accredited as such with the Tourist Promotion authority) qualify for 100%
depreciation.

Accelerated depreciation for fuel conservation expenditure

An initial year accelerated depreciation allowance is available on the capital cost of

purchasing certain new assets, converting existing oil-fired plant to non-oil-fired plant, or in
improving the efficiency of fuel-using equipment or other expenditure to reduce fuel
consumption (e.g. insulation measures).

The rates, in addition to normal depreciation, are:

Modification of equipment for the purpose of conserving fuel input 20%

Expenditure on converting oil-fired to non-oil-fired plant 30%
Expenditure on purchasing new non-oil-fired plant 30%

Oil fired plant refers to equipment fuelled principally by imported oil (including LPG.)

Solar heating: Expenditure on the purchase and installation of solar heating plant for use in
earning income is available as an outright deduction.

Example

A firm operated diesel driven equipment which had a written down value of K845, 000, which
it depreciated at the rate of 10% per year (diminishing balance method). It spent K80, 000 at
the end of June on the equipment to increase its fuel efficiency. The firm also installed a solar
heating system at a cost of K60, 000 to reduce its dependency on electricity. Depreciation in
respect of this expenditure would be calculated as follows:

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Depreciation: diesel equipment 845,000 x 10% 84,500
Fuel conservation depreciation allowance 80,000 x 20% 16,000
+ Normal depreciation 80,000 x 10% + 1/2 4,000
Solar heating expenditure 60,000
Total depreciation expenditure 164,500

At the end of the year the ‘residue’ of fuel conservation expenditure in respect of the diesel
equipment (80,000 – 20,000 = 60,000) would be capitalised and added to the written down
value of the equipment as follows:

Diesel equipment: written down value – start of year K845,000

Fuel conservation expenditure 80,000
925,000
Less depreciation 84,500
16,000
4,000 104,500
Written down value – end of year 820,500

Tourism plant

Plant used in the operation of hotels and other short-term accommodation facilities is included
in the definition of eligible property and as noted above a deduction of 20% of the cost is
allowed in the year of acquisition, in addition to the normal depreciation allowable. From 1
January 2007 this initial deduction was increased 55% of the cost of the tourism plant,
provided the plant is new (not previously used) or a new addition to an existing asset (i.e. a
building extension). From 1 January 2008 restaurants have also been able to benefit from the
initial 55% depreciation deduction.

Expenditure on boats and ships (and ancillary equipment) used solely as dive boats or used
by a person carrying on a business as an accredited scuba diving/snorkelling tour operator
qualify for the 100% accelerated depreciation deduction.

Example

A company which operates a number of hotels in Papua New Guinea, purchases a new hotel
located in Port Moresby from a construction company for K500m. The hotel satisfies the
criteria of being a tourist facility for the purposes of the 55% accelerated provision in Section
73 of the Act. Consequently, 55% of the cost price (K275m) may be claimed as a depreciation
charge in 2013 in addition to the normal rate of depreciation (e.g. 2%). The remaining
depreciation charge of K215m (K500m less K275m less K10m) will be claimed over the life
of the hotel at the standard depreciation rate.

NOTE: the 55% accelerated depreciation in such cases applies only to new buildings or to
new additions to existing facilities used for short term accommodation. If the hotel had been
in operation when it was purchased (i.e. was not new), or the rooms are used for long term
accommodation, the 55% accelerated provision would not apply.

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Accelerated depreciation for agricultural, fishing and tourism activities

Expenditure on new plant or articles:

• used directly for the purposes of agricultural production; or

• used solely for commercial fishing activities of residents qualifies for the 100%
accelerated depreciation deduction.

An accelerated depreciation deduction of 20% of the cost of most other new items of plant
and equipment (with a life exceeding 5 years) used for the purposes of agricultural production
is also available. This allows an accelerated deduction for items of plant or articles which are
not used directly in agricultural production.

Accelerated Depreciation for Manufacturers

Industrial plant not previously used in Papua New Guinea is eligible for accelerated
depreciation of up to 100% of cost. The claim for accelerated depreciation cannot take the
company into a tax loss (but can be carried forward and claimed in a subsequent year). To
qualify, the plant must have an effective life for tax purposes exceeding five years and must
be used by the taxpayer or any other person (e.g. a lessee in a manufacturing process.

Expenditure on new buildings for the housing of industrial plant, or for the storing of raw
materials or finished products also qualifies for the 100% accelerated depreciation.

An accelerated depreciation deduction of 20% of the cost of most other new items of plant
and equipment (with a life exceeding 5 years) used by a manufacturer is available.

Depreciation and sale of leased assets

Normally payments in respect of leased assets consist of monthly are lease rental payments
and one final payment equal to the residual value of the asset. A taxpayer is allowed a full
deduction each year for lease monthly lease rental payments made. The residual value
payment represents the cost of the asset at the time this payment is made and is acquired by
the person making the lease payments. The asset may then be amortised. Depreciation may
be claimed based on the residual value of the asset.

Depreciation should not be claimed at the same time as lease rental payments are made as a
tax deduction is being claimed in respect of these payments.

When a leased asset is sold, any gain on disposal will be treated as assessable income (Section
47C). The amount assessable will be the lesser of the difference between the selling price and
the residual value payment, and the total amount of lease payments made for which deductions
have been claimed.

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Example

A taxpayer leased a vehicle and made ten payments of K6, 000 (K60, 000) and one residual
value payment of K6, 000. The vehicle was then sold for K14, 000. The amount to be
included as assessable income would be K9, 000 that is the difference between the selling
price and the residual value payment. If the vehicle were sold for K66, 000, assessable income
would be K60, 000 that is the total amount of lease payments made.

Pooling of depreciation assets

From year 2001 onwards, taxpayers are allowed to ‘pool’ their assets. Assets purchased after
January 2001 that cost K1, 000 or less may be immediately expensed, i.e., they may be
claimed as an outright deduction. Assets which cost more than K1, 000 but less than K100,
000 may be pooled together. This means all assets with the same depreciation rate may be
pooled together and depreciation calculated on the value of the pool at the end of each year.

The pool may change in value each year as a result of additions to and disposals from the
pool. Balancing charges and deductions resulting from disposals are ignored.

Assets costing more than K100, 000 (and all buildings) may not be pooled and should be
depreciated individually.

Asset value Treatment

Less than K1, 000 Immediately expensing
More than K1, 000 but less than K100, 000 May be pooled
More than K100, 000 No change

Taxpayers have the choice to elect to pool assets as described above. During the first year of
operation, the written down value of existing assets may be transferred into the appropriate
pool.

Additions to the pool are made in the year following the purchase of new assets. This is to
prevent a full year’s depreciation being claimed on assets purchased during the year. The
written down value of the acquired assets at the end of this first year may then be transferred
to a pool. This might also take into account any accelerated depreciation claimed.

Where assets are pooled the diminishing value method of depreciation must be used.

Example

A company has a vehicle depreciation pool consisting of vehicles that are depreciated at 30%
diminishing value method. Written down value at start of year is K1.4 million. In the previous
year it purchased new vehicles which cost a total of K480, 000. Written down value at the
end of the year was K450, 000. It also disposes of vehicles for K250, 000.

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 The written down value of the pool at the end of the year would be calculated as follows:

Value – start of year 1,400,000

Additions 450,000
1,850,000
Disposals 250,000
1,600,000
Depreciation @ 30% 480,000
Value – end of year 1,120,000

As can be seen, calculating depreciation for assets that are pooled is a simple and
straightforward exercise. When assets are sold, the sale price is simply deducted from the
pool. The written down value of the disposed asset is not considered, because once assets are
pooled it may not be easy to ascertain the written down value of individual items.
Depreciation is calculated on the easy to ascertain the written down value of induvial items.
Depreciation is calculated on the value of the pool at the year-end, regardless of when
disposals have occurred during the year.

The pooling of assets for depreciation purposes has been introduced in many countries, its
main advantage being that of simplicity. In order to fully benefit from this approach, the
number of depreciation rates should be reduced so that the number of depreciation pools are
limited. For this reason, it is expected that the IRC will issue revised asset lives in order to
reduce the number of depreciation rates currently available.

Rates of Depreciation

The IRC has fixed standard depreciation rates on a wide variety of assets. The rates specified
are for plant of average type used under normal working conditions. For plant and equipment
used under abnormal working conditions, higher depreciation rates may be permitted. If a
business purchases an asset for which no depreciation rate has been fixed, the taxpayer must
approach the IRC to determine the useful life of the asset and hence establish the depreciation
rate.

The following is a list of the more common rates set down by the IRC.

A full list of depreciation rates for tax purposes appears in the CCH edition of Papua New
Guinea Income Tax Legislation.

Percentage Allowable
Prime Cost Diminishing
Types of Asset (Straight-line) Balance
Method Method
Fixed assets normally used by business enterprises:
Air-conditioning plant 10.0 15.0
Buildings (office and employees’
accommodation):
Brick, stone and concrete structures 2.0 3.0
Wood, iron and fibro 3.0 4.5
Buildings (storage purposes):
Steel-framed 4.0 6.0
Wooden framed 7.5 11.25
Lifts and elevators 6.0 9.0

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 Electrical
Electrical Machinery and Equipment
Hand tools and loose plant - Replacement -
Other Plant 7.5 11.5
Electric vacuum cleaners 10.0 15.0
Fans 7.5 11.25
Neon signs - electronic 7.5 11.25
Entertainment:
Snooker tables 2.5 3.75
Radios, stereograms & televisions 10.0 15.0
Household items used for commercial purposes by
hotels, restaurants, shops, offices:
Carpets 2.0 30.0
Crockery (plates, cups, etc.)
Cutlery (knives, spoons, etc.) cooking
utensils - Replacement -
Curtains 10.0 15.0
Furniture & fittings 7.5 11.25
Refrigerators (not refrigeration plant) 7.5 11.25
Washing machines 7.5 11.25
Machinery & Equipment for the following industrial
activities:
Battery (dry) manufacturing plant 10.0 15.0
Bone-milling plant 7.5 11.25
Bookbinding plant 7.5 11.25
Boot & shoe manufacture 7.5 11.25
Box (cardboard) machine 7.5 11.25
Building industry:
Earth moving plant 20.0 30.0
Concrete mixers 15.0 22.5
Immersion vibrators 25.0 37.5
Trowelling machines 25.0 37.5
Cranes 10.0 15.0
Power tools (hand operated):
Electric or pneumatic power 20.0 30.0
Welding plant 7.5 11.25
Cement, pipe & tile manufacture 10.0 15.0
Canning plant (Fruit & vegetables) 7.5 11.25
Clothing, millery, white-work manufacturing
plant:
Sewing machines 10.0 15.0
Others 5.0 7.5
Furniture-maker’s plant 10.0 15.0
Industrial gas manufacturing 7.5 11.25
Match manufacturing 7.5 11.25
Nail manufacturing 7.5 11.25
Paint manufacturing 10.0 15.0
Pottery plant 7.5 11.25
Rope & twine manufacturing 7.5 11.25
Rubber manufacture:
Moulds 10.0 15.0
Process 20.0 30.0
Salt manufacturing & refining 7.5 11.25
Smelting plant 15.0 22.5

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Office Machines & Equipment:
Cash registers 10.0 15.0
Computers (hardware) 20.0 30.0
Other data processing equipment 15.0 22.5
Other office machines & equipment 10.0 15.0
Primary Industries, farmers, etc
Cocoa & Coffee industry plant
Dryers:
Rotary or spin 10.0 15.0
Sun – metal 5.0 7.5
- wooden 10.0 15.0
Fermenting Vats, etc:
Cement 5.0 7.5
Wooden 15.0 22.5
Pulpers 10.0 15.0
Storage Bins (Cement) 3.0 4.5
Copra Industry Plant
Dryers:
Ceylon type – Concrete 5.0 7.5
- Timber/iron 10.0 15.0
Forced air type – drying chamber 5.0 7.5
- air blower 10.0 15.0
Hot air & Samoan type 10.0 15.0
Fishing:
Boats (excluding ships & steamers) 10.0 15.0
Sails, oars, running gear, nets, etc - Replacement –
Meat works plant 10.0 15.0
Rice milling plant 7.5 11.25
Printer’s Plant & Machinery:
Linotype metal - Replacement –
Machinery 10.0 15.0
Stereos & blocks - Replacement –
Types 20.0 30.0
Road-Making Plant:
Air-compressor & motors 10.0 15.0
Bulldozer, road graders & rollers 20.0 30.0
Other plant 15.0 22.5
Timber, firewood & Sawmilling Plant:
Log Hauling Plant 25.0 37.5
Saws (Mobile) 15.0 22.5
Wharves 5.0 7.5
Other Plant & Machinery 15.0 22.5
Transportation:
Aircraft 15.0
Jet 10.0 18.75
Turboprop Jet 12.5 37.5
Helicopter 25 30
Other 20 22.5
Automatic car washing machines 15.0 15.0
Boats 10.0 11.25
Ships & steamers 7.5 30.0
Motor vehicles (including bulldozers, buses, 20.0
trucks, tractors, forklifts, etc.) 37.5
Motor vehicles for hire 25.0
Plant & machinery for repairing 15.0
- Motor vehicles 10.0 22.5
- Trailers 15.0

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Miscellaneous
Cameras 10.0 15.0
Garbage bins 15.0 22.5
Lawn mowers – motor 20.0 30.0
- other 10.0 15.0
Public address systems 10.0 15.0
Safes - portable 2.5 3.75
- other Nil Nil
(Where telephone installations owned by the
taxpayer)
Computerised PABX system 5.0 7.5
Fax machines 10.0 15.0
Soft drink vending machines 20.0 30.0

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Self-assessment Exercises
Question 1

On 1 February 200X Helen Lim acquired a new computer for her business. The invoice from
the suppliers showed the following:

K
Computer 4,500
Delivery fee 40
Installation fee 60
Computer software 1,500
Maintenance for computer for 12 months 150
6,250

Assuming that the computer has an effective life of four years, what deductions would Lim
be entitled to claim in 200X tax year?

Question 2

A company purchased a motor vehicle and in order to get it ‘on the road’ the following costs
were incurred:

Cash price of vehicle K14,000

Bank charges 750
Stamp duty on sale 108
Comprehensive insurance 350
Third party insurance and registration 200
Optional extras 2,000
Deposit paid 2,500

Which of the above expenses would be capitalised for depreciation purposes?

Question 3

A company purchased a truck on 1 August 2012 for K180,000. The diminishing value method
was used for calculating depreciation for tax purposes.

A. Calculate the depreciation allowance for year of income 2012 and 2013 and the written
down value for each year.

B. If the prime cost method was used, calculated the written down value of the vehicle at
the end of each year.

Page | 119
Question 4

A fast food restaurant that operated mainly at night was robbed its takings four times in as
many months in 200X. It decided to cease operating here and transferred its operations to
Port Vila, Vanuatu. The sale of its assets (written down value K570, 000) amounted to K840,
000. Net taxable income for the year amounted to only K180, 000 on account of extraordinary
losses due to the robberies.

Calculate tax payable for the year. The business was not incorporated.

Question 5

A transport company’s chief source of income is the transportation of fuel throughout the
country. During the year of income, the following transactions occurred:

• On 31 March it purchased a ship for K1.2m for the purpose of transporting refined oil
within Papua New Guinea. (Depreciation rate 11.25% p.a.).

• On 30 June it sold a motor vehicle for K10, 000. The cost price was K9, 000 and the
written down value was K3, 000 at the date of sale.

• On 31 August it purchased a motor vehicle for business purposes for K30, 000.

Calculate the depreciation under the diminishing value method and other loss or gains on
disposal for the year of income in question.

Question 6

A furniture manufacturer installed new equipment with a life exceeding 5 years which cost
K125, 000. Installation and delivery costs amounted to a further K7, 000. The depreciation
rate used on its buildings is 2% straight-line method. Written down value of buildings used
to house the equipment at start of year was K360, 000. Purchase price: K600, 000.

Calculate allowable deductions for depreciation and written down value of the buildings at
the end of the year of income.

Question 7

A company uses diminishing value method of calculating depreciation in respect of the

following assets:

Cost Opening W.D.V Rate

Machine 1 80,000 15,200 15%
Machine 2 150,000 30,000 15%
Machine 3 400,000 250,000 15%
Motor Vehicle 59.940 36,000 30%

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On 30 May, a fire destroyed Machine 3 and a sum of K300,000 was received by way of
insurance.

On 30 July, a new Machine 4 was purchased and installed to replace Machine 3. Detail of the
purchase was:

Purchase price K400, 000

Transportation 1, 000
Import duty 4, 000
Installation costs 1, 300
Minor repairs to damage in transit 1, 000

Calculate depreciation allowances for the year of income for the above assets and written
down value at the end of the year, and any assessable income to be included in the taxation
return. Note that no additional depreciation beyond normal depreciation is allowable for the
purchase of the new machine.

Question 8

The following is a Profit & Loss statement for a certain sole trader:

Gross profit from trading activities 500,000

Other income:
Discount received 20,000
Bad debts recovered 10,000 530,000
Less costs
Audit fees 5,000
Bad debts 6,000
Bank charges 2,500
Commissions 12,000
Depreciation 11,400
Discounts allowed 3,500
Interest 2,500
Legal expenses 8,400
Office expenses 19,700
Repairs 9,000
Wages 105,000 185,500
Net Profit 344,500

Other information:

• Bad debts are for amounts previously declared as assessable income

• Legal expenses are for:
• Court fines 1,400
• Renewal of lease 1,800
• Debt collection 1,000
• Employment contract 700
• Obtaining franchise rights 3,500
• Repairs – extension to office premises 4,500
• Wages include salary to the sole trader 20,000
(salary or wages tax not deducted)

Calculate taxable income and tax payable. The sole trader has three dependants.

Page | 121
Answers to Self-Assessment Exercises

Question 1

The computer and its associated delivery and installation costs, plus software, are capital
expenses, so depreciation may be claimed based on the sum total. The amount spent on the
maintenance agreement is allowable outright under section 68 (1). The approved depreciation
rate for computers (including software) is 30% using diminishing value method.

Depreciation is calculated as follows:K6, 100 x 30% x 334/365 = K1, 675

The amount deductible to Hellen Lim is 200X tax year is:

Depreciation of computer 1,675

Maintenance 150
K1,825

Question 2

Capital costs available for depreciation purposes:

Cash price K14,000

Stamp duty 108
Optional extras 2,000
*Qualifying expenditure 16,108

*Qualifying expenditure refers to expenditure on which the depreciation calculation is based.

Bank charges are spread over five years or the term of the loan. The other items are of a
recurring nature and can be written off against the first period’s profits.

Question 3

A. Qualifying expenditure K180, 000

Depreciation 2012: 180,000 x 30% x5/12 22, 500
Written down value 31/12/13 157, 500

Depreciation 2013: 157,500 x 30% 47,250

Written down value 31/12/13 110,250

B. Qualifying expenditure K180,000

Depreciation 2012: 180,00 x 20% x 5/12 15,000
Written down value 31/12/12 165,000

Depreciation 2012: 180,000 x 20% 36,000

Written down value 31/12/13 129,000

Page | 122
Question 4

Balancing charge: K270,000

Notional income: K180,000 / 3 = K60,000
Tax on K60,000 = K17,900

Rate of tax payable = 29.83%

Tax on net income of K180,000 = K5,369,400

Question 5

The ship assumed to have a working life of more than 5 years; is new and will be used for the
first time in Papua New Guinea.

Cost price 1,200,000

Normal depreciation 101,250
Accelerated depreciation (20%) 240,000 341,250
Written down value – end of year 858,750

Motor vehicle disposal: Assessable gain: 10,000 – 3,000 – 1,000 (capital profit) = 6,000

The company may offset the balancing charge of K6,000 against the replacement vehicle, in
which case depreciation would be calculated on K24,000 (30,000 – 6,000).

Depreciation on motor vehicle – assuming based on K24,000: K2,400 (4 months –

diminishing value method).

Question 6

Depreciation on installed equipment in this case may be 100% of total expenditure of

K132,000, provided this does not exceed net income – in other words no loss may be carried
forward.

Depreciation on buildings: 2% x 600,000 = K12,000

Written down value of premises (at start of year) K360,000

Less depreciation 12,000
Written down value (at end of year) 348,000

(Note that accelerated depreciation up to 100% may also be claimed for buildings which house
industrial plant.)

Page | 123
Question 7

Asset Depreciation WDV – end of year

Machine 1 2,280 12,920
Machine 2 4,500 25,500
Machine 4 25,456 (5 months) 381,844
Motor vehicle 10,800 25,200

Gain on insurance recovery on Machine 3 is K50,000 (300,000 – 250,000). This is assessable

income. However, the company may elect to treat this as a balancing charge to reduce the
depreciable value of Machine 4 to K357,300; in which case depreciation claimed for Machine
4 would be K22,331 and its written down value at yearend would be K334,969.

Note that no depreciation may be claimed for Machine 3 because its WDV at start of year is
used to calculate the balancing charge.

Question 8

Net profit as per Profit and Loss Statement 344,500

Add: Non-deductible/Assessable items

• Legal expenses:
• Fines 1,400
• Franchise rights (capital) 3,500
• Repair – extension 4,500
• Salary to sole trader 20,000 29,400
• (appropriate of net profit)
Taxable income 373,900

Income Tax payable (at personal income tax rates) 143,248

Less dependent rebates 1,050 142,198

Note: Repairs expenditure may be claimed as part of depreciation of the office premises.
Franchise expenditure may also be amortised over a number of years.

Page | 124
Self-Assessment Test

Question 1

The prime cost method of calculating depreciation

a) Allows for the same amount of depreciation on an asset to be claimed annually

b) Is calculated at 1.5 times the diminishing value rate

c) Enables more depreciation to be claimed in the early years of an asset

d) Is more appropriate if higher profits are anticipated in the early years

Question 2

A construction company purchased a bulldozer with an expected life exceeding 5 years and
has claimed accelerated depreciation.

a) 20% accelerated depreciation may be claimed since the bulldozer is ‘eligible property’

b) Up to 100% depreciation may be claimed since it is plant equipment

c) The company may claim depreciation to reduce taxable income to nil

d) No accelerated depreciation deductions are available

Question 3

A transport company’s chief source of income is the transportation of fuel throughout the
country. During the year of income, the following transactions occurred:

• On 31 March it purchased a ship for K1.2 m for the purpose of transporting refined oil
to Papua New Guinea. (Depreciation rate 11.25% p.a.). The ship is assumed to have a
working life of more than 5 years; is new and will be used for the first time in Papua
New Guinea.

• On 30 June it sold a motor vehicle for K20,000. The cost price was K18,000 and the
written down value was K6,000 at the date of sale.

• On 31 August it purchased a motor vehicle for business purposes for K30,000.

Which of the following is correct?

a) Depreciation allowable for the ship is K341,250.

b) Balancing charge in respect of vehicle disposal is K12,000.

c) Assuming balancing charge is offset against vehicle purchase, depreciation on new

vehicle is K3,000.
d) All of the above.

Page | 125
Question 4

You work in the accounting/tax division for a big trucking company which has just sold off
some vehicles at a tremendous profit compared with written down value. You are concerned
about the impact on the taxable income of such a profit being brought to account for tax
purposes and so you take advice from your local CPA qualified accountant. He advises you,
quite correctly, that if you do not want to bring in the profit from depreciation recouped (there
is no capital gain compared with costs) you can: -

a) Deduct the profit from the written down values of other plant you have on hand.

b) Deduct the profit from the cost of new plant that you have purchased in that year.

c) Deduct the profit from the cost of replacement plant.

d) All of the above.

Question 5

A furniture manufacturer installed new equipment with a life exceeding 5 years which cost
K125,000. Installation and delivery costs amounted to a further K7,000. The depreciation
rate used on its buildings is 2% straight line method. Written down value of buildings used
to house the equipment at start of year was K360,000. Purchase price: K600,000.

Which of the following is correct?

a) 20% accelerated depreciation may be claimed for the new equipment installed.

b) Depreciation up to K132,000 may be claimed for the new equipment installed.

c) Depreciation of K7,200 may be claimed for the buildings.

d) Written down value at end of year buildings will be K352,800.

Question 6

Accelerated depreciation is available at up to 100% of the cost of the plant for:

a) Plant used directly in agricultural production, fishing boats and eligible plant used in a
manufacturing process.

b) Eligible plant used in a manufacturing process, acquisition of non-oil-fired plant and

plant used directly in agricultural production.

c) Fishing boats, plant used directly in agricultural production and leisure facilities.

d) None of the above.

Page | 126
Question 7

On 1 January 2013 PNG Company purchased two properties – Villa Lodge (“VL”) for K100m
and Hotel Surprise (“HS”) for K200m. Both are considered as tourist facilities under the
income tax act. VL was built in 2006 while the construction of HS has just been completed
and is designed to house long term tenants in apartment style living. PNG Company’s
accountant wants to claim a total of K165m in accelerated depreciation on both properties in
2013, under the 55% accelerated depreciation provision allowable for short term tourist
accommodation. You tell her:

a) Only 55% of the cost of VL can be claimed in 2013, because it is for short term
accommodation.

b) Only 55% of the cost of HS can be claimed in 2013, because it is new and VL was built
in 2006.

c) 55% of the costs (K165m) of both VL and HS can be claimed in 2013.

d) The 55% accelerated depreciation provisions for the purchase of short-term tourist
accommodation do not apply to VL or HS is not new, and HS, while new, is not for
short term accommodation.

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Answers: Self-Assessment Test

Question 1

a) is correct. b) is incorrect because the diminishing value method rate is 1.5 times the straight-
line method rate. c) and d) are incorrect – they are correct in respect of the diminishing value
method.

Question 2

a) is correct. due to the availability of fuel locally from Napa Napa, the bulldozer would not
necessarily rely on imported fuel and hence it may be considered ‘eligible property’. b) And
c) Are incorrect since the asset is not involved in a manufacturing process, and so 100%
maximum depreciation cannot be claim. d) Is incorrect.

Question 3

d) is correct answer as can be shown from the following:

Cost 1,200,000
Normal depreciation 101,250
Accelerated depreciation (20%) 240,000 341,250
Written down value – end of year 858,750

Motor vehicle disposal: Assessable gain: 20,000 – 6,000 – 2,000 (capital profit) = 12,000

The company may offset the balancing charge of K12,000 against the replacement vehicle, in which
case depreciation would be calculated on K18,000 (30,000 – 12,000).
Assuming this is the case, depreciation will be K1,800 (4 months – diminishing value method).

Question 4

e) is correct as all are available choices under the act and are termed as balancing charges.

Question 5

b) is correct. Up to 100% depreciation may be claimed for industrial plant (including

installation costs). a) is therefore incorrect. c) and d) are incorrect since straight line
depreciation is calculated on initial cost.

Question 6

a) is correct because all these items are eligible for the accelerated depreciation of up to 100%.

a) is not correct because the non-oil-fired plant item is not eligible for the full 100%
acceleration.

a) is not correct because leisure facilities do not qualify for depreciation at all.

a) is not correct because a) is.

Question 6

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a) is correct, for reasons given in the question

Question 7

d) is correct, for reasons given in the question.

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6. TAXATION OF INDIVIDUALS

Learning Objectives

After you have successfully completed the work in this unit you should be able to

• Identify what income is subject to personal income tax.

• Apply personal income tax rates to calculate taxable income of individuals.
• Identify dependents which are allowable for tax purposes and calculate dependent rebates for
taxpayers at different levels of income.
• Calculate salary or wage tax payable by employees for periods greater or lesser than one fortnight.
• Calculate rebates allowable for work related expenses and for educational expenses.
• Apply the correct formula to calculate tax payable on non-salary income.
• Explain the tax treatment of non-salary expenses and losses.
• Explain the tax treatment of employment related benefits and allowances.
• Explain how the income of sole traders and partnerships is taxed.
• Explain how provisional tax is levied and payable on non-salary income.

Personal Income Tax

Each individual is assessed separately for tax purposes. There is no joint assessment of the income
of husbands and wives, unlike in certain other countries. The income of an individual, which is subject
to tax, includes:

• Salary or wages (employment income or remuneration).

• Value of allowances and benefits: e.g. housing, vehicle, electricity and other employee benefits
(all treated as salary or wages income).
• Business income from a sole trader or partnership business.
• Investment income in the form of dividends and interest.
• Gifts such as trips from clients or customers like those received by waiters, employees of
supermarkets etc (treated as salary or wages income). If a gift is received but has no connection
with work, it is not taxable.
• Workers’ compensation weekly or other periodic payments for loss of wages. Payments received
in one lump sum for serious injury, such as loss of limb, are not taxable.
• NASFUND and other superannuation fund payouts.
• Royalties: to landowners for minerals, oil or timber taken from their land; or payments to
inventors or authors for their work.

From 1 January 2019 the individual tax rates for residents who has lodged salary or wages tax
declaration form is as follows:

Taxable Income Tax thereon (K) Rates of tax on excess (%)

12,500 Nil 00
20,000 2, 420 22
33,000 6,920 30
70,000 19,870 35
250,00 91,870 40
250, 000 and more No limit 42

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From 1 July 2012 the individual tax rates for residents was as follows:

Taxable income Tax thereon (K) Rates of tax on excess (%)

10,000 Nil 22
18,000 1, 760 30
33,000 6,290 35
70,000 19,210 40
250,000 91,210 42

Non-residents are taxed at different rates, which are covered in the Unit on “Taxation of Non-residents
and Overseas Income.” It is most important that you are able to interpret the above table and apply
it correctly to calculate a person’s tax liability.

Consider the following examples of how tax payable by individuals is calculated for different levels
of income.

Tax income 12,500

Tax payable Nil (not above minimum threshold)

Total tax payable Nil

Taxable income 22,000

Tax payable (22,000 – 20,000) x 22% = 440
Plus 2, 420

Total tax payable 2,860

Taxable income 80,000

Tax payable (80,000 – 70,000) x 35% = 3, 500
Plus 19,870

Total tax payable 23,370

Taxable income 180,000

Tax payable (180,000 – 70,000) x.35% = 38,500
Plus 19,870

Total tax payable 53,370

Taxable income 350,000

(350,000) x.40% = 147,000
Plus Nil

Total tax payable 147,000

The ‘tax free threshold’ is K12,500 (if a Salary or Wages declaration is completed and lodged). In
other words, income is tax free up to K12,500. The top rate of tax is 42%. Sometimes the rate of tax
on a person’s next kina of income is simply referred to as the ‘marginal rate’ of tax. A taxpayer’s
marginal rate of tax is the tax payable on the top portion or slice of their income. For example, a
person earning a salary of K23,000 per year would be paying a marginal rate of tax of K33% (although
their average rate of tax is approximately 17%).

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Concessional (dependant) rebates (Division18A’ Section 213A-Section 213F)

Taxpayers are allowed a tax rebate for maintaining certain dependants. It should be understood that
only certain persons are regarded as dependants for tax purposes.

A dependant for tax purposes is defined to mean a person who is:

• A spouse of the taxpayer: the husband or wife of the taxpayer.

• An unmarried child of less than 16 years who is wholly maintained by the taxpayer.
• A student receiving full-time education who is over 16 but less than 25 years.
• An invalid relative, who is permanently incapacitated (incapable through injury, disablement or
sickness) from work and has been officially certified as such by a medical officer of the Public
Service. They must be the taxpayers’ child, brother or sister and be not less than 16 years of age.
• A parent of the taxpayer or of his spouse who is resident in Papua New Guinea. They must not
be maintained partly or wholly from subsistence farming. Nor must they receive support from
any other members of the family.

No rebate is available:

• Where the separate net income of a dependant exceeds K1,040, or more than K40 per fortnight.
• If the dependant is maintained either wholly or partly from subsistence farming, or
• If more than one member of the family or other person contributes towards the maintenance of
that dependant.

Dependant rebates are allowed recognition of the domestic responsibilities of taxpayers and are
intended to provide a measure of relief for those taxpayers. Where a taxpayer contributes to the
maintenance of a dependant, a payment in cash is not the only acceptable method. The provision of
food, lodging and clothing represents contributions to the maintenance of a dependant, as do
payments towards a child’s education.

In order to claim a rebate for dependants, a Salary or Wages Declaration form, obtainable from an
employer, should be completed. If claiming for an invalid relative, a certificate from a Government
Medical Officer must be attached to the declaration, stating that the relative is permanently unable to
work. A letter of approval from the IRC should also be attached to the declaration when claiming
for an invalid relative or for a parent.

A new declaration should be completed each time an employee’s entitlement to dependants’ rebates
changes. For example, an employee may have an additional child to claim for. Taxpayers are entitled
to the following dependant rebates for up to a maximum of three dependants:

First dependant 15% of gross tax payable: but not more than
K450, or less than K45
Second and Third dependants 10% of gross tax payable: but not more than
K300, or less than K30
Study the following examples, which show how dependant rebates are calculated:

Taxable income K10,300 One dependant

Gross tax payable: 66
Less dependent rebates 45
Net tax payable (66 – 45)

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The minimum amount of K45 is allowed because it is more than 15% of K66, which is K9.99.

Taxable income K14,000 Three dependents

Gross tax payable: (K4,000 x .22) 880.00
Less dependent rebates 880x 15% = 132.00
880 x10% = 176.00 308.00

Net tax payable (880 - 308) 572.00

Taxable income K40,000 Three dependents

Gross tax payable: (2,450 + 6,260) 8 ,710
Less dependent rebates 450 x 1 = 450
300 x 2 = 600 1,050

Net tax payable (8,710 – 1,050) 7,660

Note that in the last example, the maximum amounts allowable have been used, i.e. K450 for the first
and K300 for the other dependants, respectively. 15% of gross tax payable would exceed the
permitted maximum rebates in each case (15% of 8,710 = 1,307)

The sum of dependant rebates allowed to a taxpayer shall not exceed K1,050.

The following table indicates approximately the levels of income for which the minimum and
maximum dependant rebate amounts should be applied, and the income range for which the
percentage formula should be applied – the box below needs to be updated for FY12 tax rates (ie
minimum taxable amount is K10,000).

Income Dependant Rates

1st Dependant 2nd & 3rd Dependants

Less than K11,385 K45 K30 each

K11,385 – K22,135 15% of gross tax 10% of gross tax
Over K22,135 K450 K300

If a husband and wife are both working, they may not both claim rebates for the same dependants.
Either one may claim, or they share in claiming the rebates. To gain maximum benefit, the person
on the highest income should claim for all dependants. A wife earning K25,000 could claim K450
for one dependant while her husband, earning K11,000, could claim only K45 for the same dependant.

Salary or Wages Tax: PAYE (Pay As You Earn) or Group Tax.

For the purpose of income tax, salary or wages include (Section 65E):
• Normal fortnightly salary or wages.
• Employment related allowances: for example, housing or use of a vehicle, whether in cash or in
kind.
• Commissions and bonus payments.
• Gratuities.
• Fees for professional services performed.
• Payments by a company to its directors, and
• Superannuation payouts (e.g. NASFUND. Or Nambawan Super payments).

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Salary or wages are subject to fortnightly assessment of tax [Section 65 1 (2)]. This is also known as
pay as you earn (PAYE), or Group Tax. Non-salary or wage income, such as income from a business,
dividends, interest or rent is assessed for tax on an annual basis. For these purposes a fortnight is a
period of 2 weeks consisting of 14 consecutive calendar days.

An annual salary or wage is divided by 26 to convert it to a fortnightly income. The annual salary or
wages of public servants or employees of statutory corporations are converted to a fortnightly income
by the National Computer Centre (NCC) using the following formula:
Gross Pay x 12 = fortnightly income.
313

The fortnightly tax tables are based on the tax rates contained on page 2 of this module and were most
recently published by the IRC to reflect the new tax rates effective from 1 July 2012 (the following
commentary is made with reference to the tax tables issued by the IRC with effect from 1 July 2012).
They are converted to tables showing tax payable over fortnightly periods. Dependant rebates are
incorporated into the fortnightly tables. So, it is not necessary in practice to calculate dependant
rebates for taxpayers receiving a wage or salary income only.

All employees must complete a Salary or Wages Tax Declaration from in order to benefit from
dependant rebates. Any employer allowances and benefits must also be listed (the taxation of these
is considered later). This form must be given to the employer to enable the correct amount of fortnight
salary of wage tax deductions to be calculated. An employee how does not complete a declaration
from will be taxed at the rates listed in Column 3 of the Tables, under the heading “Where no
declaration is lodged”. The rate in this column is 42% for all levels of income.

Column 2 of the fortnightly Tax Tables shows tax payable for non-residents (considered in Unit 8).
Column 4 is the column you will normally refer to. It lists the fortnightly tax payable for residents
claiming up to three dependants.

Table A covers fortnightly income levels up to K776. Residents in this category who have lodged a
tax declaration pay no tax on their income.

Table B covers fortnightly incomes ranging from above K776 to K950.

Table C covers fortnightly incomes above K950. Although no tables are provided, the guidelines for
calculating tax payable on wages and salaries over K950 are given and they are straight forward. The
table is reproduced at the end of this chapter, however for someone with income of more than K950
and submitted a declaration, the tax payable is as follows:

• For amounts of K950 per fortnight, tax payable is K115.38 plus 30 toea for each K1 by which the
fortnightly salary exceeds K950.

• For amounts over K1,277 per fortnight, tax payable is K213.46 plus 35 toea for each K1 by which
the fortnightly salary exceeds K1,277.

• For amounts of K2,700 per fortnight, tax payable is K711.54 plus 40 toea for each K1 by which
the fortnightly salary exceeds K2,700.

• For amounts over K9,623 per fortnight, tax payable is K3,480.77 plus 42 toea for each K1 by
which the fortnightly salary exceeds K9,623.

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Sums may be deducted from the gross table amount for dependants as follows:

1 Dependent K17.31 2 Dependents K28.85 3 or more Dependants K40.38

These are the maximum amounts that may be claimed for dependants calculated on a fortnightly
basis. You will recall that the maximum amount that can be claimed for (3) dependants is K1,050
per year, which on a fortnightly basis amount to K40.38.

It is important when reading the tax tables that you refer to the correct row of figures and the correct
column. Use a ruler if possible. Mistakes are most often made by referring to the row either above
or below the correct row. For example, take a person with a salary of K433 per fortnight with three
dependants. This person would pay K4.91 tax. If the salary were K433.50 tax would be K5.35 tax
would be K5.35. You must pay special attention to the column headings exceeding and not exceeding
in column 1.

Take care also when using Table C – which refers to income over K950 per fortnight (reproduced at
the end of this chapter). In most cases you will be referring to Column 3 on the right – where a
declaration is lodged. For this reason, it is wise to put a pencil stoke through Columns 1 (especially)
and 2.

The fortnightly salary or wages tax is a ‘first and final’ tax. That means, nor refunds of salary or
wages tax are allowed where an employee has worked for periods less than one year. An employee
will be assessed for tax according to the fortnightly salary or wages tax tables. These rates are worked
out on the assumption that an employee earns income, and pays tax on that income each fortnight,
during the whole year (Section 299D & Section 65 (2)).

Example

A person with no dependants earns K600 in one fortnight. That is all the income earned throughout
that year. Tax payable will be K45.91 according to the salary or wages tax tables. Although taxpayers
are entitled to a tax-free allowance of K10,000 it only applies calculating the salary of someone who
has worked each fortnight throughout the year. (in this case the employee is given 1/23 of K10,000
as tax free).

How to Calculate Salary or Wages Tax for Periods Other Than a Fortnight

Wage earners will sometimes receive payments for periods other than one fortnight, or in addition to
their fortnight pay. The IRC has definite rules on how these payments should be taxed. Its basic
approach is to first of all calculate how much tax would be payable if the tax period was one fortnight.
Then a proportional amount of tax payable is calculated for the period concerned.

In addition to the following examples, refer also to the example given at the back of the fortnightly
salary or wages tax tables issued by the IRC.

Tax payable on salary or wages for more than one fortnight (Section 29D(2)(c)).

The Salary or Wage is calculated as the full number of fortnight’s tax and the pro rata part of the
fortnight remaining for the period,

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Example

An employee is paid K900 for the month of January. He has lodged a Declaration claiming no
dependants.

January has 31 Days (ie 2 Fortnights and 3/14 of a fortnight)

Salary earned during each fortnight K900/31 x 14 = K 406.45
Fortnightly Tax (no Dependants) = K 3.23
Total Tax for the month:
- First fortnight = K 3.23
- Second fortnight = K 3.23
- 3/14 fortnight = K 0.69
Total tax to be deducted = K 7.15

Tax payable for a period less than one fortnight.

A. Weekly.

The (2) two weekly amounts in each fortnight are added together

Example
An employee receives K 280.00 per week and has lodged a declaration claiming
(1) dependant.

Fortnightly salary or wages K 280.00 x 2 = K 560.00

Tax on Fortnightly salary or K 560.00 (1 Dependant) = K 31.55
Tax Per Week (K 31.55/2) = K 15.77

B. Other than weekly.

(i) Continuous employment

The fortnightly equivalent of salary or wages is calculated. Salary is based on 14 days per fortnight
and the tax is then apportioned to the days actually worked.

Example

An employee receives K 250.00 for eight (8) days’ work. He has not lodged a declaration.

Fortnightly salary or wages = K 250 / 8 x 14 = K 437.50

Tax on Fortnightly salary of K 437.50 = K 184.38
(no declaration Lodged)
Tax on eight days work for K 250.00 = K 184.38 / 14 x 8 = K 105.36

(ii) Commencement or cessation of employment

The fortnight equivalent of salary or wages based on 11 days per fortnight, and the tax is then
apportioned on the actual number of days worked.

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Example

An employee commences employment and earns K 224 for 7 days worked up to the end of the
fortnight. He has lodged a declaration claiming two (2) dependants.

Fortnightly salary or wages K224 / 7 x 11 = K352.00

Tax on Fortnightly salary of K352 (2 Dependants) = K0.00
Tax on seven days’ work for K224 = K 0.00 / 11 x 7 = K0.00

Payments in Advance

When employees go on leave, they may receive leave pay in advance. This leave pay is taxed as if it
were received over normal fortnightly periods.

Example

An employee receives K1,180.00, representing 5 weeks leave pay in advance. He has lodged a
declaration claiming three (3) dependants.

5 weeks = 2.5 Fortnights (35 days)

Salary per fortnight
Tax on K472 (3 Dependants)
Tax on 5 weeks
Total tax to be deducted
=k1,180 / 35 x 14
= K472.00
= K 11.54
= K 11.54 (first fortnight)
= K 11.54 (second fortnight)
+ 5.77 [7/14 x (11.54)]
= K 40.39

Payments in Arrears

When back payments are included in wages, they should be taxed as if they were received in the
period they were earned. They should not be taxed as a lump sum. Back payments may be paid for
overtime or back payments of wage increases, etc.

Example

An employee received K82 for overtime in respect of the three (3) pervious fortnights. He normally
receives K450.00 per fortnight and has lodged a declaration showing no dependants.
Step 1: The payment is broken up into the amount application to each fortnight. In this example
these are:

a. K22 First fortnight

b. K40 Second fortnight
c. K20 Third fortnight

Step 2: Add the overtime to the total salary or wages earned by the employee for the
previous fortnights.

a. First fortnight K450 + K22 = K472

b. Second fortnight K450 + K40 = K490
c. Third fortnight K450 + K20 = K470

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Step 3: Calculate the tax applicable to the new gross salary at the no dependant rate.

New Gross New Tax Old Tax Tax to be

Salary deducted
1st f/night K472 17.75 12.91 K 4.84
2nd f/night K490 21.71 12.91 K 8.80
3rd f/night K470 17.31 12.91 K 4.40
Total K18.04

Points to note:

1. Overtime earned in the current pay period is to be added to an employee’ normal pay and
taxed accordingly.

2. Where back payment, such as a bonus is received not representing a specific period of time,
the amount is to be apportioned over the number of fortnights during which the service was
performed. In nearly all case a period of time will be specified, and this condition will not
apply.

The maximum period for calculations on all payments is 26 fortnights except where the back pay
covers a period where there has been a change in tax rates, in that case the period is restricted to 6
years.

Gratuity payments

A gratuity is a lump sum payment, paid to an employee under the terms of a contract. Gratuity
payments were taxed at 2% until 1 January 1993. Since then they are taxed at normal tax rates. Few
private sector employees receive gratuity payments as they don’t result in tax savings. In the public
sector, contract officers (citizen and non-citizen) may receive gratuity payments under the terms of
their contracts.

To calculate tax payable on a gratuity, the payment is spread over the period for which it applies
(usually six months – 13 fortnights) and tax calculated. For employees earning over K33,000 (but
less than K70,000), this effectively means that tax payable on a gratuity is 35%.

Termination lump sum payments (Section 46B)

A salary or wage earner employed with the same employer for a number of years, who resigns or is
terminated will normally receive lump sum back payments upon resignation or termination. These
termination payments are, under Section 46B (3), apportioned over the previous 26 fortnights in order
to calculate tax payable (see example which follows). In certain limited circumstances some parts of
termination payments may be taxed at 2% (S.46B(2)). For example, long service leaves, which
accrued before 1 January 1993, is taxed at 2%.
Accrued annual leave: This is apportioned over the period for which the leave applies or 26
fortnights, whichever is less. For example, a taxpayer with 6 weeks accrued annual leave would have
it apportioned over 26 fortnights.

Accrued long service leave (furlough): In the 2018 budget changes were made
to Section 46B of the Income Tax Act and the Rates Act in order to rationalize the treatment of certain
payments made to employees on termination of employment. Starting from January 2018 certain
payments lot Long Service Leave (LSL), made upon termination of employment, attract concessional
rates of Salary or Wages Tax.

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Payments of LSL, made on bona fide termination of employment, new Section 46B2 was inserted to
include LSL accrued at a rate not exceeding 6 months per 15 years of service with an employer or
associated person of that employer when the employee has completed a minimum of 15 years
continuous service. These payments are to be taxed under Section 1(2) of the Income Tax (Salary or
Wages Tax) (Rates) Act 1979. The effect of these changes is that qualifying payments of Long Service
Leave are taxed at 2%.

Superannuation: Payments from such funds as NASFUND and Nambawan Super are taxable when
received by employees. It is understood the IRC considers it is only the employers’ contribution and
the accumulated interest component of the payment that is taxable. However, this may not be
technically correct in circumstances where the concessional tax rates apply.

The 2% rate applies to distributions, being prescribed sums, from Authorised Superannuation Funds
where the payment was:

a. Accrued prior to 1 January 1993; or

b. in respect of contributions made on behalf of the employee, for not less than 15 years, or
c. in respect of contributions made on behalf of the employee, for not less than 7 years, where the
employee is subject to enforced early retirement, or
d. made as a result of the death or permanent disability of the employee, for not less than 7 years,
where the employee is subject to enforced early retirement, or
e. made as a result of the death or permanent disability of the employee.
f. in any other case the Authorised Superannuation payments should be taxed with reference to the
following table:

Years of Less than 5 years Not less than 5 years Not less than 9 years
Contributions and not greater than 9 and not greater than
years 15 years
Rate of Tax Marginal Rate of Tax The lesser of 15% of The lesser of 15% or
the marginal rate of the marginal rate of
tax tax

Payments that include amounts accrued after 1993 are taxed in the following way:

• If contributions (to a fund) were less than five years – taxed at normal tax rates (spread over a
period of 26 fortnights).
• If contributions were for more than five years and no greater than nine years – taxed at lesser of
15% or at normal tax rates.
• If contributions were for more than nine years and no greater than fifteen years – taxed at lesser
of 8% or at normal tax rates.

Superannuation funds may establish a Retirement Savings Account (RSA) which provides an option
for contributors to save money for future draw down (income stream), rather than taking the total
payout as a lump sum. As an incentive to invest in an RSA, the earnings are tax-free provided the
drawdowns are within the following limits.

• Where the amount in the RSA exceeds K20,000, the RSA cannot be drawn by more than 30% per
annum.
• Where the amount is the RSA exceeds K10,000 but does not exceed K20,000, the RSA cannot be
drawn down by more than 50% in any one year.
• Where the amount is less than K10,000, the RSA cannot be drawn down by more than 50% in the
first year but can be drawn down in full in any subsequent year.

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 The maximum balance for an RSA is K250,000. Where there is a withdrawal from an RSA in
excess of the prescribed limits the tax exemption on earnings from the RSA will not be affected.
Excess withdrawals are taxed at 30%.

Example

An employee aged 47 has resigned from ABC Pty Ltd on 31 December 2013 after twenty-four (24)
years of service with the company. He is paid a standard fortnight wage of K800.00; has two (2)
dependants and does not receive any allowances. He is paid the following termination payment:

1. Accrued recreational leave (3 fortnights) K2,400.00

Accrued long service leave
2. Accrued prior to 1/1/93 (4.4 fortnights) K3,520.00
3. Accrued after 1/1/93 (16.4 fortnights) K13,120.00
4. Ex Gratia payment K8,000.00
5. Payment in lieu of notice (6 fortnights) K4,800.00

Items 1, 3, 4 and 5 do not attract any concessional rate of tax and must be taxed at the employees’
marginal tax rate. i.e. spread over the previous 26 fortnights and tax calculated. This is calculated as
follows:

Items 1, 3, 4 and 5 added together = K28,320.00

Spread over 26 fortnights. i.e., K28,320.00 /26 = K 1,089.23

Add to normal fortnight pay (K800.00 + K1,089.23) = K1,889.23)

Item 2 complies with the criteria for concessional tax under Section 46B of the Act” and so is taxed
at 2%.

The difference between tax on K800 (K73.49) and tax on K1,889.23 (K426.20) at 2012 rates (2
dependants) = K352.71 per fortnight.

Therefore, tax on the K28,320.00 would be:

(26 x K352.71 = K9,170.46

Summary of tax payable

Tax at marginal rate = K9,170.46
Tax at concessional rate (2% x K3,520.00) = K 70.40

TOTAL TAX PAYABLE = K9,240.86

Concessional Taxation of Redundancy Payments

As part of the 2011 Budget (which came into effect in 2012) was a scheme which grants concessional
tax treatment to employee who receive redundancy payments, subject to satisfying certain conditions.

The concessional taxation treatment is available in cases where individuals are made redundant under
an approved redundancy scheme. The following provides details of what a redundancy payment is
and the conditions employers need to satisfy in order for their individual employees to benefit from
the scheme.

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Redundancy Payments

Under the Income Tax Act, a “redundancy payment” means so much of a payment:

a) Made under an approved redundancy scheme; and

b) received by an employee who is dismissed from employment because the employee’s position
is genuinely redundant, and at the time of the dismissal, there was no arrangement between
the employee and the employer, or between the employer and another person, to employ the
employee after the dismissal; and
c) as exceeds and amount reasonably be expected to be received by the employee in consequence
of the voluntary termination of their employment at the time employment ceases; and
d) if the dismissal was not at arm’s length, the amount that does not exceed the amount that could
reasonably be expected to have been made if the dismissal were at arm’s lengths,

but does not include so much of a payment.

i. received in lieu of superannuation benefits to which the employee may have become entitled
at the tie the payment was received or at a later time; or
ii. a superannuation benefit; or
iii. a payment of a pension or any annuity (whether or not the payment is a superannuation
benefit); or
iv. an unused annual eave payment; or
v. an unused long service leave payment; or
vi. a payment that is an advance or a loan to an employee on terms and conditions that would
apply if the employee and the employer were dealing at arm’s length; or
vii. a payment that is deemed to be a dividend under this Act; or
viii. an amount included in your assessable income in relation to an employee share scheme; or
ix. a capital payment for, or in respect of, personal injury to an employee; or
x. a capital payment for or in respect of a legally enforceable contract in restraint of trade.

Approved Redundancy Scheme

The Commissioner General shall approve a redundancy scheme if he is satisfied that at least 30
employees are to be genuinely made redundant under that scheme or employees are genuinely made
redundant form the public sector. The employer is required to apply in writing for approval from the
redundant from the public sector. The employer is required to apply in writing for approval from the
Commissioner General with the application containing the following information:

• The positions to be made redundant; and

• The amounts of the redundancy payments; and
• The amounts of the concessional components; and
• The amounts of salary and wages of eligible taxpayers; and
• Any other information prescribed by the Commissioner General.

Eligibility

In order to be eligible for such treatment, the taxpayer must be a resident of PNG and satisfy the
following conditions:

a) has had at least five years of continuous service with an employer; and
b) receives a redundancy payment upon termination of their employment with the employer
under an approved redundancy scheme; and

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 c) is dismissed before the earlier of the following
(i) The day he or she turned 65.
(ii) If the taxpayer’s employment would have terminated when he or she reached a
particular age or completed a particular period of service, the day or she would reach
the age or completed the period of services (as the case may be); and
(iii) Who has not previously received an amount from the employer which has been taxed
under this section?

Tax Treatment

The rate of tax applicable to a redundancy payment is 15% up to a cap determined by reference to the
“concessional component” calculation. The concessional component is the lesser of PNGK50,000 or
the amount from the following formula:

Base Amount + (Service Amount x Years of Service) where:

• “base amount” means K5,000; and

• “service amount” means K2,000; and
• “years of services” means the number of completed years of continuous service during which
the taxpayer was employed by the same employer.

Amounts in excess of the cap will be subject to tax at marginal rates.

Allowance for Expenditure Incurred in Earning Income [Section 214(1—3)]

Incorporated in the fortnightly salary or wages tax rates is an allowance of K200 for every salary or
wage earner. This blanket deduction of K200 per year is for expenses incurred in earning salary or
wage income.
For example, if someone earns a salary of K12,000 per year, they are taxed as if their income is
K11,800. If employee related expenses exceed K200, the taxpayer may be entitled to a tax rebate
equal to 25% of the expenditure (which exceeds K200).

Examples of expenses which are subject to this rebate include:

• Subscriptions to technical, scientific, trade, business or professional journals. Also, the purchase
of books (if not used for more than one year). These journals and books must be connected to the
particular work of the employee. If books are kept on a permanent basis, they are classified as
part of one’s professional library which is treated as capital, for which depreciation may be
claimed
• Subscriptions to trade, business or professional associations (e.g. CPA PNG)
• Where the taxpayer is carrying on a business deduction are allowed up to a certain limit for each
association (S.94)
• Conference expenses. Travel expenses incurred by an employee in attending a conference relating
to the person’s work (less any reimbursement from employer).
• Travelling expenses. Although travelling from home to one’s place of work is a private expense,
travelling from one’s place of employment to another, if one has more than one job, is an
allowable expense.
• Overseas travelling expenses. A taxpayer engaged in a skilled profession, in order to maintain
his professional knowledge and skill, is allowed to claim for overseas travelling expenses while
attending conventions, seminars, etc.
• Expenses on clothing and footwear. Only expenses on clothing and footwear necessary and
peculiar to the taxpayer’s occupation will be allowed: Normally expenditure on clothing and its

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 maintenance is treated as private expenditure and therefore not tax deductible. However, under
the ‘necessary and peculiar’ test the following may qualify for deductibility: boiler-maker’s
overalls; butcher’s and chef’s aprons; nurses’ uniforms; waitresses and flight attendants’
uniforms; boots for telephone linesmen; special gloves for welders etc.
• Expenses on tools, equipment etc. Expenditure in replacing and repairing tools of trade in certain
trade workers, electricians may claim the cost of tools or instruments. Teachers may claim for
calculators, computer discs and general teaching aids. Hairdressers may claim for coms, curlers,
razors, etc
• Self-education/training expenses. These are also only allowable in very limited circumstances;
for example, when an employee, as part of his conditions of employment, has to undertake certain
training or complete a particular course; or where promotion is conditional on successfully
completing a course.

Consider the following example:

A taxpayer incurs the following employment related expenses during the year:

Travelling expenses 650

Subscription to journals 125
Total 775
Less: already allowed 200
Total 575
Rebate allowed at 25% 143.75

Some employment related expenses are treated as capital expenditure and a depreciation allowance
is granted instead of a tax rebate. For example, a depreciation allowance is granted for expenditure
on books for professional purposes that are kept for over one year, computers and equipment.
Example

An employee earning K12,000 per year spent K2,000 on a computer and printer in connection with
his employment. He is allowed to depreciate these assets for assets for tax purposes at 20% (straight
line) or 30% (reducing balance) per annum. Assuming the straight-line method is used, the tax rebate
would be calculated as follows: 2,000 x 20% = K400 x 25% = K100.

If the computer was used for private purposes, e.g. For games, allowance would need to be made for
this, and the rebate adjusted downwards.

Rebates for other expenditure incurred

Salary and wage earners are also entitled to a rebate when expenditure of the following nature is
incurred:

• Gifts to charitable or sporting bodies, Foundation of Law, Order and Justice, or political parties.
• Certain expenditure incurred by primary production companies in which one has shares (see Unit
4)

One IRC approval is obtained, a rebate of 25% is allowed.

When a taxpayer is claiming a tax rebate for work related expenses or for other expenditure incurred,
they must submit a tax return at the end of the tax year. Such a claim is treated as an ‘objection’ to
the person’s tax assessment.

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 The tax return must be submitted within 60 days after the end of the tax year for it to be considered.

Tax Allowances for Education Expenses (Section 70 & Section 214B)

Resident taxpayers are entitled to a tax rebate for fees paid to a non-government primary or high
school, whether in Papua New Guinea or overseas. Any subsidies or assistance should be deducted
from the allowable amount.

From the year 2001 onwards, the rebate is limited to the lesser of 25% of net education expenses
incurred or K750 per dependant student child.

Example

A taxpayer has an allowable education expense of K5,000 for his daughter’s fees paid to a private
high school. The rebate entitlement would be K750, being the lesser of K1,250 (25% of K5,000) and
the maximum allowed of K750.

This rebate should be claimed at the end of the tax year in question by submitting an income tax
return.
How to calculate tax payable on net income?

Sometimes an employee may, as part of his employment package, be guaranteed a net income after
tax. For example, he may receive a net salary of K50,000 after tax. In this situation it is necessary
to calculate the employee’s gross income in order to calculate tax payable on the net amount.

The following computer formula may be applied, using a spreadsheet, to calculate gross income and
tax payable from a given net income figure.

Net income rage Net pay Gross pay Tax payable

0 – 10,000 ? = Net pay Nil

10,000.01 – ? = (net pay – 12,500*22%)/78% = (gross pay – 12,500) x 22%

16,240

16,240.01 – ? = (net pay – 20,000*2,420)/70% = (gross pay – 16,240.01) x 30% +

26,740 2,420

26,740.01 – ? = (net pay – = (gross pay - 26,740.01) x35%+6,920

50,790 33,000*35%+6,920)/65%

50,790.01- ? = (net pay- = (gross pay - 50,790.01)

158,790 70,000*40%+19,870)/60% x40%+19,870)

158,790.01- ? = (net pay- = (gross pay - 158,790.01)

250,000*42%+91,870)/58% x42%+91,870

You must first enter the formulae as above in the ‘gross pay’ and ‘tax payable’ columns. For ‘net
pay’ and ‘gross pay’, you must enter the correct cell numbers, for example, B5, C4.

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If you want to calculate tax payable on an amount between K33,000 and K70,000, insert the net pay
figure in the net pay column, next to the 33,000 – 70,000 income range cells. The correct gross pay
and tax payable figure will then appear, once the formulae have been entered in the cells.

Below is an example of how gross pay and tax payable is calculated, once the above formulae have
been entered in the cells.

Net income range Net pay Gross pay Tax payable

26,740 – 20,790 35,000 45,707 10,707
50,790 – 158,790 150,000 235,350 85,350
158,790 - 200,000 321,051 121,051

Taxation of Employment Related Benefits (Regulation 9 A)

You already learnt that allowances and benefits are considered part of an employee’s income. These
allowances and benefits, also known as fringe benefits, are given a taxable value for salary or wages
tax purposes. We shall now consider them individually.

Accommodation

The prescribed taxable value (per fortnight) of accommodation owned by, or rented by, an employer
who is provided to an employee is as follows:

TYPE OF HOUSING AREA 1 AREA 2 AREA 3

Very High Cost House or Flat 2,500 1,500 NIL

Up-Market Cost House of Flat 1,500 1,000
NIL
HIGH COST House or Flat 700 500 NIL
MEDIUM COST House or Flat 400 300 NIL
LOW COST House or Flat 160 150 NIL
MESS OR BARRACK STYLE 7 7 NIL
ACCOMMODATION

EMPLOYEES INVOLVED IN AN APPROVED NIL NIL NIL

CITIZEN EMPLOYEE FIRST TIME HOME
BUYER SCHEME

The distinction between very high cost house or flat, up-market cost house or flat, high cost house or
flat, medium cost house or flat, low cost house or flat is as follows:

Very High cost Accommodation that would fetch K3,000,000 or more if sold on the open
housing market or a weekly rental equal to K7,000 or more.
Accommodation that would fetch less than K1,500,000 and K3,000,000 if
Up-Market cost sold on the open market or a weekly rental between K5,000 and K7,000.
High cost housing Accommodation that would fetch less than K800,000 if sold on the open
market or a weekly rental of K3,000 but less than K5,000.
Medium cost Accommodation that would fetch between K400,000 and K800,000 if sold
housing on open market or a weekly rental of K1,000 and less than K3,000.
Low cost housing Accommodation that would fetch K400,000 if sold on open market or a
weekly rental of K1,000 or less.

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The arears mentioned refer to the area located in or within a 15-mile radius of the boundaries of any
of the following towns.

Area 1 Goroka, Lae, Madang, Mount Hagen, Port Moresby, Kokopo, Alotau and
Kimbe
Area 2 Bulolo, Daru, Kainantu, Kavieng, Kerema, Kiunga, Kundiawa, Lorengau,
Mendi, Popondetta, Porgera, Tabubil, Vanimo, Wabag, Wau, Wewak, Buka,
Arawa, Lihir and Rabaul.
Area 3 Any place within Papua New Guinea not included in Areas 1 and 2.

Employees provided with accommodation outside Papua New Guinea by their employer are
automatically deemed to live in high cost housing in Area 1.

Example

An employee earns K2,000 per fortnight and occupies a house in Lae for which the employer pays
K550 in rent each week. This accommodation would therefore be classified as a low-cost house.

Taxable value of accommodation: K160 – low value amount (per fortnight)

Taxable fortnightly income: K2,000 + K160 = K2,160.

(Do not make the mistake of thinking that the prescribed taxable value, in this case K160, is the actual
amount of tax paid on the benefit).

Low cost housing

Under the Low-Cost Housing Scheme, a low-cost house is valued at K75,000 or less. Although under
the new program referred to as the ‘Citizen Employee First Time Home Buyer Scheme’ the value
will be replaced to K400,000.

Stamp duty concession is also available to first home buyers. A first-time citizen home buyer is only
subject to stamp duty on the portion of the purchase price that exceeds K500,000.

Motor Vehicle

The taxable value of a vehicle and fuel provided by an employer is K125 per fortnight or K95 per
fortnight if a vehicle only is provided.

Example

An employee receiving K2,000 per fortnight is provided with a company vehicle, but with not fuel.
Taxable income would be K2,000 + K95=K2,095.

Employees who incur expenses by using their own vehicles in the course of their employment may
claim a tax rebate under Section 214 concerned with work related expenses). But they would have
to produce sufficient details of business use. If the employer pays an allowance to cover the
employee’s expenses, it is fully taxable.

A variation in the amount of tax payable can be requested if the allowance is actually acquitted.

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Meals

Where an employee is provided with daily ‘messing’ type meals, ie. Meals in a staff canteen, the sum
of K30 is added to the employee’s salary or wage.

Education Expenses [Section 40(3)]

The taxable value of allowances for education fees for children of employees is nil. The fees must
be paid directly to the school or as a reimbursement. (The receipt must also be made out to the
employer – not the employee). This s is an example of exempt income. However, in the case of
tertiary (Eg. University) education, allowances are fully taxable.

Leave Fares and airline tickets [Section 40AA & Section 65E(j&k)]

One annual fare for an employee and his family to the place of recruitment or origin is tax-free.
Additional leave fares are fully taxable. The taxable value of any additional fares is the actual cost
to the employer. Leave fares to workers employed on a ‘flyn-in’fly-out basis’ in resource (mining,
petroleum and gas) projects located in ‘remote’ areas (deemed as such by IRC) are exempt.

Airline employees and travel consultants are also taxed on any discounted airline tickets that they
receive. The taxable value of such a benefit is the actual value of the discount provided.

For example: an airline employee pays K80, or 10% of a full economy fare that costs K800. The
discount received is therefore K720. The taxable value of this benefit is therefore this amount –
K720.

The taxable value of a taxable leave fare is included in the fortnightly income for the period when the
airfare is paid and taxed at the taxpayer’s marginal rate.
Superannuation Funds

The contribution by an employer to an approved superannuation fund within Papua New Guinea, is
tax free to an employee. As a general rule the contribution is usually not more than 15% of an
employee’s fully taxed salary and wages income. Contributions to a non-resident fund are also tax
free to the employee. However, when an employee receives a payout it is assessable where paid by
a resident fund but subject to concessional rates of tax (refer to example earlier). Where the payout
is from a non-resident fund to an employee resident in PNG the whole amount is assessable income.

Electricity, Gas, Telephone, Domestic Servants, Security Services and Club Membership
Schemes. (Regulation 9)

If an employer pays an allowance to cover any of the above expenses for an employee, it is taxable
in the hands of the employee. However, if the employer makes the payment on behalf of the employee
it is not taxable to the employee.

In the later case no deduction is allowed to the employer (except for telephone where evidence of
business use is provided).

Entertainment

Entertainment allowances received by employees are fully taxable. Moreover, employers are also
denied a deduction for entertaining expenses in the form of allowances, food drink or recreation,

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except in very limited circumstances. Such exceptions include entertainment provided at a seminar,
or to promote or advertise a business or product.

Cash allowances

Cash allowances are taxable in full to the employee. However, a tax variation may be approved in a
limited number of circumstance (see next).

Calculating the tax liability on employee provided benefits

An employer is responsible for the calculation, deduction and remittance of Salary or Wages Tax.
The tax is calculated on the total assessable salary or wages for a fortnight. For an employer to
comply with their obligations in this regard, the total amount of salary or wages must include all
assessable benefits, allowance and other payments received, earned or derived for that fortnight.

Example

An employee earns a salary of K725 per fortnight. In addition, the employee is provided with a car
with fuel, a house rented for K900 per week in Port Moresby. He also had his electricity of K80 paid
on his behalf and received a reimbursement of K150 for entertaining business clients on the
employer’s behalf. He also received a telephone allowance of K15 per fortnight and had yearly
subscription for health insurance paid of K520. During the fortnight the employee worked six (6)
hours overtime at K11.00 per hour and received a commission of K45 for sales made. He has lodged
a declaration claiming 3 dependants. The calculation of the employee’s taxable salary is as follows:

Salary 725
Overtime 6 hours x 11.00 66
Commission 45 111

PLUS
Assessable Benefits at prescribed rates.

Car 125
Telephone 160 285

PLUS
Other Assessable Benefits and Allowances.

Medical Insurance 20
Telephone 15 35

Total Taxable Salary or Wages 1,156

Tax Calculated as follows (using table “C”):

Tax on K950.00 K115.38

Tax on 206.00 (x.30) 61.80
Tax on K1,156.00 K177.18
Less Rebate for three (3) dependants 40.38
Net Tax payable on income of K1,156.00 K136.80

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Other assessable benefits and allowances: The actual amount paid is to be included in the
calculation of taxable Salary or Wages. If the amount applies to more than one fortnight the
assessable amount is calculated by apportioning the amount over the fortnights involved and
recalculating the tax to be deducted and remitted for those periods.

Variations in Salary or Wages Tax (Section 299E)

Where an employee receives a cash allowance for housing or work-related expenses incurred, or to
be incurred, such a cash allowance would normally be taxable. However, the employee/employer
can apply to the IRC requesting a variation in the salary or wages tax to take into account an expected
rebate on work related expenses. A variation in this context is an approved change in the amount of
tax payable. So that an employee is not out of pocket until the end of the year, until a tax return is
processed, a variation in tax may be approved. A request for a variation must be made in writing
together with fully supported documentation for each type of expenditure.

For example, the evidence required to verify or prove expenditure in the case of a vehicle would be
logbooks or records showing details of mileage and destinations, and receipts.
If this evidence was acceptable to the IRC a variation would be approved for a cash allowance to be
paid which would not be taxable. Where a variation is granted, the employee is required to lodge an
income tax return.

Example

An employee in Port Moresby receives a housing allowance of K350 per week (K700 per fortnight).
This enables him to rent low cost accommodation. This allowance is taxable in full in addition to his
normal salary of K1,000. However, if a variation has been obtained from IRC, the employee would
be taxed on the prescribed value of the benefit, ie. K160 per fortnight. Fortnightly taxable income
would be K1,160.

If a housing allowance exceeds the actual rental payment, the excess is taxable in full. So, if in the
above example, the employee rented a house for K250 per week, the excess of K100 per fortnight)
would be fully taxable. If a citizen employee receives a housing allowance, which is used to repay a
loan for a house in an approved low cost-housing scheme, the allowance is tax-free.

First time homeowner repayable amounts

Loans or advances paid from amounts owed in respect of recreation leave, long service or gratuity in
order to enable citizen employees to purchase their first home are not taxable provided the cost of the
property is K75,000 or less.

Taxation of benefits at marginal rate

The effect of benefits and allowances being taxed is that they are taxed at the top marginal tax rate
paid by the taxpayer. This can be illustrated by a simple example:

A person’s salary income is K29,000 per year. They receive employer-related benefits, which are
fully taxable. These benefits amount to K4,000 per year.

Taxable income is therefore K33,000. Using personal income tax rates, tax payable on K33,000 is
K6,920. The benefits of K4,000 have been taxed at 30% which is the taxpayer’s (top) marginal rate.

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Taxation of Non-Salary Income

A person may earn income in addition to salary or wage income. For example, a person may earn
income from running a business or having a share in a business, from owning rental property, from
owning shares or bank deposits, which earn dividends and interest. Tax on such additional income,
known as ‘non-salary income’, is calculated by reference to the personal income tax rates.

Many taxpayers will also earn income solely from business, for example, sole traders. Their income
will also be taxed at personal income tax rates.

There is a formula for calculating tax payable on non-salary income, which is as follows:
A–B = C where

A = Gross tax payable at personal income tax rates on total salary or wage income plus
other income.
B = Gross tax at personal income tax rates on salary or wage income; and
C = Payable on income which has not borne salary or wage tax

Example

Tina Taxpayer receives a salary of K20,000 per year plus she received net rental income of K5,000.

Gross tax payable on K25,000 3,860

Less gross tax payable on K20,000 2,360
Tax payable on non-salary income I,500

Non-Salary Expenses and Losses [Section 214 (4)]

Expenses incurred in gaining non-salary income are allowable deductions only against that income.
For example, costs incurred as part of the carrying on of a business may be deducted against income
earned by that business. These deductions may include:

• wages paid to employees.

• interest on borrowed funds.
• travelling expenses.
• depreciation of income producing assets such as building, motor vehicles, machinery and
equipment.
• rates, advertising expenses, repairs and maintenance to rental properties.

Example

Salary K30,000
Business income 250,000
Less expenses 70,000 180,000

Taxable income K210,000

An employee, however, who suffers a loss in respect of non-salary income can obtain a refund of
salary or wages tax because of that loss. Such losses may, for example, relate to business losses, or
rental property within Papua New Guinea or primary production investment deductions.

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Example

A salary earner has a yearly salary of K30,000. He incurs a non-salary loss of K4,000 during the
year. The tax rebate will be calculated as follows:

The taxpayer has paid tax on K30,000. He should have only paid tax on K26,000 (30,000 – 4,000).
Recalculate the below based on 2012 tax rates.

Gross tax payable on K30,000 = 5,360

Gross tax payable on K26,000 = 4,160
Rebate entitlement 1,200

The actual rebate shall not exceed salary or wages tax paid. An application for a rebate should be
made by submitting a tax return. The application would be deemed an objection [Section 24 (5)].
Provisional Tax (Section 300 – 311)

An individual who earns non-salary income is subject to advance payment of tax on that income,
known as provisional tax. Every taxpayer who earns more than K100 in non-salary income is subject
to provisional tax. This includes sole traders and partners of a business (to be considered later). The
most common type of non-salary income is interest, rent, dividends and distributions from
partnerships.

Provisional tax is levied on non-salary income to ensure that, as far as possible, all income is taxed
in the year in which it is earned. In calculating provisional tax, an assumption is made that non-salary
income earned during the year will be at a level similar to that of the previous year. Provisional tax
will therefore normally be similar to tax paid on non-salary income in the previous year. Provisional
tax will therefore change, provisional tax changes by the same proportion.

The tax is payable no earlier than 30 September of the year of income. Taxpayers are later given a
credit for this advance tax payment in the following year.

Generally provisional tax included on the notice of assessment is payable on the same date as income
tax for the preceding year.

Example

In the year 2012 a taxpayer has a salary of K150,000 for which salary and wages tax is paid throughout
the year. The taxpayer also earned K50,000 in non-salary income during 2012. This income is
declared in the taxpayer’s tax return submitted in early 2013. Tax liability on this income is calculated
to be K20,000 (71,210 – 51,210) *.
The taxpayer is also assessed for provisional tax for 2012, based on the level of non-salary income
earned during 2012, ie. K50,000. Provisional tax payable in this case would therefore be K20,000.

During 2013 the taxpayer earns the same salary of K150,000. Non-salary income earned during the
year amounts to K165,000. This income is declared in the taxpayer’s tax return submitted in early
2013. Tax on this non-salary income is calculated to be K67,300. The taxpayer receives a credit for
K20,000 for provisional tax paid on this income in the previous year, so the net amount payable would
be K47,300.

The taxpayer would also be liable for provisional tax for 2013, based on the 2013 level of non-salary
income – L165,000. Provisional tax in respect of 2013 income would amount to K67,300.

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 *Tax on total income (150,000+50,000 71,210
Less tax on salary (51,210)
income
Tax on non-salary 20,000
income

A taxpayer may have reasons to believe that his non-salary income will be less than the previous year.
He may request in this case to have the provisional tax payable changed and based on a lower level
of income. The IRC normally allows taxpayers to change the provisional tax payable based on the
taxpayer’s own estimates. However, there are penalties for underestimating the level of noon -salary
income actually obtained.
Taxation of Sole Traders

You are already familiar with how non-salary income is taxed. Where the source of income for an
individual is from a business only, taxable income should be calculated as follows:

1. Calculate income for tax purposes

2. Calculate the tax payable on the taxable income by applying personal income tax rates

3. Deduct all tax rebates which the individual is entitled to receive

4. Add provisional tax payable to the figure obtained. This will normally be the same figure.

From this figure, deduct the provisional tax paid in the previous year.

Example

A sole trader with three dependants has taxable income of K400, 000 for 2013.

Provisional tax earlier paid in respect of this income amounted to K154,250 (based on 2012 income
of K400,000).

Tax payable in 2013 for 2012 income 154,870

Less dependent rebates 1,050
Tax payable 153,820
Plus, provisional tax for 2013 153,820
307,640
Less provisional tax paid for 2012 154,250
Net tax payable 153,390

Sole traders as well as other persons in receipt of business, or non-salary, income only, are also
entitled to claim as a deduction school fee expenses for dependent children attending non-government
schools.

Taxation of Partnerships (Section 123 – 127)

The term ‘partnership’ for income tax purposes covers a wide meaning, which includes every
unincorporated association of persons carrying on business in common with the aim of making a
profit. It also includes joint owners of property and persons in joint receipt of income.

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A partnership is required to submit to the IRC a return of the income of the partnership. But the
partnership is not liable to pay tax on such income. The partnership return determines the net
partnership income. The individual partners must then include in their personal returns their
individual shares of the profits. The IRC is not concerned with how partner’s individual share is
broken up – weather is received as interest, salary or remaining share of the profit. If a partner
receives a salary from the partnership, it is not subject to salary or wages tax. Rather, the total of the
partner’s share is subject to personal income tax.

A partnership loss cannot be carried forward as a deduction against future year’s assessable income.
The loss is distributed to the partners for allowance or a deduction against their individual assessable
incomes. If this results in an individual having a net loss, this loss may be carried forward.

Example

A partnership consists of two members, A and B. A receives two thirds of profits and B receives one
third of profits. A receives a salary of K100,000 and interest on capital contributed of K60,000. B
receives a salary of K50,000 and interest on capital of K60,000.

Net profit for the year 2000 amounts to K660, 000.

The shares to each partner are:

Salary Interest Remaining share
A 100,000 + 60,000 + 260,000 =420,000
B 50,000 + 60,000 + 130,000 =240,000

The IRC is concerned only that A has received taxable income of K420,000 and B has received
taxable income of K240,000. The calculation of salary and income is purely an internal method for
the partners to split up the profit.

Dissolution of a Partnership

A change in a partnership results in its dissolution (ending) for tax purposes. It will continue to exist,
if at all, only for the purpose of collecting outstanding debts and paying debts. A dissolution will
occur, for example, on the death or retirement of a member or on the admission of a new member. If
such a change occurs during an income year, a tax return must be filed for the old partnership up to
the date of the change, and a return for the new partnership from the date of change to the end of the
income year.

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TABLE C applicable from 1 January 2019.

Where an employee’s Salary or Wages exceeds K900 per fortnight in the year 2019

COLUMN 1 COLUMN 2 COLUMN 3

NON-RESIDENT WHERE NO WHERE A
TAXPAYERS DECLARATION IS DECLARATION IS
LODGED LODGED

Where fortnightly income Where fortnightly income

exceeds K950 exceeds K950

K169.23 plus 30 toea for 42 toea for every K1 in K115.38 plus 30 toea for
each K1 by which the fortnightly salary earned each K1 by which the
fortnightly salary exceeds fortnightly salary exceeds
K950 K950

Where fortnightly income Where no declaration is Where fortnightly income

exceeds K1,269 lodged it is assumed that this exceeds K1,276
is the employees second job.
K319.23 plus 35 toea for As the result, the highest tax K213.46 plus 35 toea for
each K1 by which the rate applies. The employee is each K1 by which the
fortnightly salary exceeds taxed at 42% on all of his or fortnightly salary exceeds
K1,269 her earnings. To arrive at the K1,276
tax to be deducted, simply
multiply the income earned
in the period by 0.42.

Where fortnightly income Where fortnightly income

exceeds K2,692 exceeds K2,700

K817.31 plus 40 toea for K711.54 plus 40 toea for

each K1 by which the each K1 by which the
fortnightly salary exceeds fortnightly salary exceeds
K2,692 K2,700

Where fortnightly income Where fortnightly income

exceeds K9,615 exceeds K9,623

K3,586.54 plus 42 toea for K3,480.77 plus 42 toea for

each K1 by which the each K1 by which the
fortnightly salary exceeds fortnightly salary exceeds
K9,615 K9,623

Income tax (Salary or Wages Tax Rates as per 2018 Budget Amendment)

Where a dependant’s declaration has been furnished, the amount of deduction calculated in
accordance with Column 3 of the table above is reduced by the amount sent out below opposite
the number of dependants shown on that form.
1 Dependant K17.31 2 Dependant K28.85 3 or more Dependants
K40.38

Page | 154
Self-Assessment Exercises
Question 1

Using the personal income tax rates on page one, calculate the tax payable for the following levels of
income and derived in the year ended 31 December 2019:

A. K5, 000 B. K15, 000 C. K28, 600

D. K42, 500 E. K72, 000 F. K262, 500

Question 2

State in each case whether the following dependants, provided for by a taxpayer, would qualify as
dependants for tax purposes.

a. Adopted daughter aged 10 years.

b. Dependant with a part time job who earns K50 per week.
c. Son aged 23 studying at UNITECH.
d. Father who lives in Brisbane for most of the year.
e. Child aged 15 already married.
f. Sister aged 18.
g. Son aged 18 unemployed.
h. Brother aged 32 unable to work because of stab wounds.

Question 3

Use the personal income tax rates in this unit to calculate (a) Dependant rebates and (b) Net tax
payable for the following taxpayers in respect of the year ended 31 December 2013:

Income Dependants
K
a. 6,600 2
b. 10,600 3
c. 15,500 0
d. 27,000 1
e. 35,000 3
f. 75,000 3
g. 285,000 2

Question 4

Refer to the fortnightly salary or wages tax tables in the appendix to find out how much tax will be
paid by employees on the following levels of income in respect of the year ended 31 December 2013.

F/n salary or wages Dependants

K
A 303.00 2
B 405.00 3
C 609.52 3
E 875.00 2
F 1,277.00 3
G 6,000.00 0

Page | 155
Question 5

A. Peter is paid a monthly salary. He receives K2000 for the month of December 2013. He has three
dependants. Calculate tax payable.

B. Joseph receives K2,250 in March 2013, which his for 3 weeks leave pay in advance, and his
normal fortnightly pay. He has two dependants. Calculate total tax paid.

C. Peter terminates his employment with his company in July 2013. He earns K11,800 per year. He
has two dependants. His final pay includes fortnightly salary, plus five weeks accumulated leave.
Calculate tax paid on his final payments.

Question 6

A. Jonah’s employment with a private company is suddenly terminated due to illness in August 2013.
He has worked for six days of the last pay fortnight. He normally receives K470 (before tax) per
fortnight for working 80 hours. He has three dependants. Calculate tax payable during this
fortnight.

B. If Jonah missed eight hours during the fortnight, calculate tax payable.

C. Naomi is a public servant with three dependants who receives K300 (before tax) per fortnight.
She missed a total of 14 hours during the last pay fortnight ended 31 August 2013 and this was
deducted from her pay. Calculate her net income after tax.

D. If Naomi missed three days during the fortnight, calculate tax payable.

Question 7

An employee with no dependants earns a normal salary of K550 per fortnight. He also received K440
for overtime for the last pay fortnight ended 14 June 2013 and the previous two fortnights. Overtime
earned was as follows:

K140 for the last fortnight; K155 for the previous fortnight; and K145 for the first fortnight. Calculate
total tax payable.

Question 8

Margaret is an employee with three dependants, earns K700 per fortnight with a firm he has been
employed with for ten years. He submits his resignation and in his final payout (paid in September
2013) receives the following terminal payments:

• Accrued leave for 8 weeks K2,800

• Superannuation payout accrued over ten years K31,200
(note that employee contribution component of payout was K9, 360)
• Long service leave K2,426 accrued since Jan 1993) K6,065
• Payment in lieu of notice (12 weeks) K4,200
K44,265

Calculate tax payable on the above lump sum assuming the amount does not exceed the “prescribed
sum”.

Page | 156
Question 9

A. Calculate the tax rebates due for the following amounts, which refer to employment, related
expenses, which have been allowed by the IRC.

K150; K450; K1, 000; K2, 500.

B. An employee incurred the following employment related expenses:

Stationery K45; Purchase of computer K3, 200; floppy discs: K55.
Subscription to trade magazine K85; daily taxi fares to and from work: K550 per year.

Calculate the tax rebate allowable for the above expenses.

Question 10

A taxpayer earning K22, 000 per year has two children both attending private schools. Total fees
amount to K7, 000 per year. The taxpayer receives no education subsidy or assistance from any
source. Calculate the tax rebate, which this taxpayer is entitled to receive.

Question 11

Refer to the fortnightly salary or wages tax tables in the appendix to calculate how much fortnightly
tax will be paid by the following employees during the year ended 31 December 2013.
Annual income Dependants Public Sector or Private Sector
K5, 000 3 Private
K10, 000 4 Public
K20, 000 2 Private
K40, 000 1 Public
K80, 000 4 Private
K100,000 1 Private

Question 12

Use a computer spreadsheet to calculate tax payable on the following net pay (after tax amounts) for
year ended 31 December 2013. Enter the formulae in the correct cells in the spreadsheet as shown in
the text:

a. K35,000
b. K85,000
c. K140,000
Question 13

An employee with three dependants who lives and works in Goroka receives K1,740 per fortnight.
In addition, he receives the following related benefits:

• Accommodation which is rented by the employer for K450 per week.

• Entertainment allowance of K100 per fortnight.
• A company vehicle (without petrol).
• Education fees of one child to private school. The annual fees amount of K6,000 per year and
are paid directly to the school by the employer.
• Employer contribution of K20 per fortnight to an authorised superannuation fund.

Page | 157
Calculate

A. Taxable income for the year ended 31 December 2013

B. Salary or wage tax payable
C. Tax rebate at end of year

Question 14

An employee in Mount Hagen with four dependants earning K2, 000 per fortnight is also provided
with the following benefits:

• Four bed roomed high cost company owned accommodation.

• Cash allowance of K250 for ‘out of pocket’ expenses per fortnight.
• Annual subscription of K650 paid to local golf club.
• Motor vehicle and petrol provided.

Calculate:

A. Taxable income.
B. Salary and wage tax payable.

Question 15

A taxpayer earns a salary of K27, 000 per year.

He also earns non-salary income of K80, 000.

Calculate tax on non-salary income in the year ended 31 December 2013.

Question 16

A taxpayer earns a salary of K57, 000. He also runs a small business whose annual gross income of
K45, 000. Allowable deductions in respect of business income amounted to K56, 000.

Calculate net tax payable by this taxpayer in the year ended 31 December 2013.

Question 17

A taxpayer with no dependants earned a salary of K20, 000 per year. Gross business income
amounted to K45, 000. Allowable deductions in respect of business income amounted to K56, 000.

Calculate tax payable by this taxpayer in the year ended 31 December 2013.

Question 18

A. A taxpayer in 2013 had a salary income of K24, 000. He also had a taxable business income of
K150, 000. Provisional tax paid in 2013 in respect of this income amounted to K57,250.
Calculate tax paid in respect of this income, stating when and how it would be paid.

B. In 2014 the taxpayer earned the same salary as in 2013. Taxable business income amounted to
K155,000. Calculate tax paid in respect of this income, including provisional tax. State when
the provisional tax would be paid.

Page | 158
Question 19

A sole trader has assessable income of K200,000 in 2013. Allowable deduction amounted to
K150,00. He also had other taxable rental income amounting to K30,000. He has three dependants.
Provisional tax paid in respect of income for 2007 was K21,000. Calculate tax payable, including
provisional tax for the following year.

Question 20

X, Y X partnership made a net profit of K200,000 in 2013 and K98, 000 in 2014. Calculate the
taxable income of each partner in 2013 and 2014.

X Y Z
Salaries K34,000 K40,000 K36,000
Interest K4,400 K3,600 K4,600

Profits and losses (after distribution of salaries and interest) are shared equally. Calculate the taxable
income of each partner in 2013 and 2014.

Question 21

In 2013 Peter earns K38,000 per year with a private company in Goroka and has the following
dependants:

Mother and father (father earn K40 per weekly from part-time employment). Daughter aged 17 is
unemployed. Sister aged 18 is attending national high school. Invalid brother who is residing with
him.

Peter obtains a cash allowance of K200 per fortnight for entertaining customers. He is also provided
with accommodation for which his employer pays K200 per week. During 2013 Peter purchased a
computer and printer for K3,000 which is used exclusively for work purposes. He also paid K350
for computer software and maintenance. Peter also runs a small business which during the year had
gross sales of K235,000 in 2013. Cost of (net) stock and materials and rental expenses amounted to
K122,500, all of which were allowable deductions. Provisional tax already paid in respect of this
income: K42,500.

A. How many dependants has Peter for tax purposes?

B. Calculate (i) Peter’s fortnightly taxable salary.
C. Calculate any rebates which Peter is entitled to receive.
D. Calculate tax on non-salary income?
E. Calculate the net amount (after provisional tax) of tax payable on non-salary income.

Question 22

IN 2013 Mary earned a salary of K20,000 per annum. She also received interest (net of 15%
withholding tax) amounting to K4,250. Calculate net tax payable on her non-salary income at year
end.

Page | 159
Answers to Self-Assessment Exercises

Question 1

A. Nil B. 1,210 C. 4,312

D. 9,770 E. 20,750 E. 110,250

Question 2

a. Dependant b. Not dependant c. Dependant

d. Not dependant e. Not dependant f. Not dependant
g. Not dependant h. Dependant (if certified as permanently disabled)

Question 3

Income (K) Dependants Rebate (K) Tax payable (K)

a. 2 0 0
6,600
b. 3 105 27
10,600
c. 0 1,210
15,500 0
d. 1 450 4,010
27,000
e. 3 5,910
35,000 1,050
f. 3 20,160
75,000 1,050
g. 2 105,160
285,000 750

Question 4

F/n salary or wages (K) Dependants Fortnightly Tax (K)

A 303.00
B 405.00
C 609.50
D 875.00
E 1,277.00
F 6,000.00
2 0.00
3 0.00
3 31.27
2 91.35
3 200.39
0 2,058.85

Page | 160
 Question 5

A. Fortnightly pay: K2000 / 31 x 14 = 903.22

Tax payable: K88.28 / 14 x 31 = 194.48

B. Total gross pay: K2, 250 (for five weeks) Fortnightly pay: K900
Tax payable: K98.84 x 2.5 = 247.10

C. Fortnightly pay: K11, 800 / 26 = 453.85

Gross pay: K453.85 x 3.5 = 588.47
Fortnightly tax payable: K10.34
Tax on K1, 588.46: K10.34 x 3.5 = 36.19

Question 6

A. Tax on K470 = K11.25

Tax for six days = 11.25/10 x 6 = K6.75

B. 6.75 /80 x 72 = K6.08 (72 is 80 hours less 8)

C. Tax on K300 = K0.00

Gross pay 300 / 75.5 x 59.5 = 242.86

Tax payable = 0.00 Below minimum threshold)
Net income after tax 242.86
D. K nil

Question 7

Gross salary Tax payable less tax paid extra tax payable
1st f/n K690 K65.75 K34.91 K30.80
2nd f/n K705 K69.19 K34.91 K34.28
3rd f/n K695 K66.59 K34.91 K31.68
Total tax payable K96.76

Question 8

Tax on normal fortnight pay of K961 = K105.61

Extra fortnightly pay: K1,000 / 13 = K76.92
New fortnightly pay: K961 + K76.92 = K1, 037.92
Tax on K1, 037.92 = K128.69
Tax on K961 = K105.61
Extra tax payable K23.08
Total tax payable: K23.08 x 13 =K300.04 + K105.61 = K405.65

Page | 161
Question 9

Sums taxed at 2%:

Employee is over 50 and contributions have been made continuously for over 7 years, so superannuation
payout (excluding employee contribution component which is not taxable) is taxable at 2%

Superannuation: K21, 840 (K31, 200 – K9, 360) Tax @ 2% K436.80

Long service leave: K3, 639 accrued prior to 1993. Tax @ 2% K72.78
K509.58

Sum apportioned over 26 weeks: 2,800 + 2,426 + 4,200 = K9,426

K9, 426 / 26 = K362.54 + K700 = K1, 062.54
Tax on K1, 062.54 = K147.60
Tax on K700 = K57.79
Extra tax payable K89.81
Total tax payable: K89.81 x 26 = K2,335.06
+ Tax @ 2% = 509.58
= K2,844.64

Question 10

A. Expenditure Rebate entitlement

K150 Nil (K200 already allowed)
K450 K62.50
K1, 000 K200
K2, 500 K575

B. All expenses allowed except taxi fares. Purchase of computer: 30% depreciation allowed (assuming
reducing balance method used) = K960
Rebate = K1, 145 – 200 = 945 x 25% = K236.25

Question 11

K750 x 2 = K1, 500 (less than 2% of education expenses)

Question 12

Annual income (K) Fortnightly salary or wages (K) Tax payable (K)
5,000 /26 192.31 0
10,000 / 313 x 12 383.39 0
20,000 469.23 66.74
40,000 1,533.55 313.25
80,000 3,076.92 849.24
100,000 3,846.15 1,180.00

(Note that although some employees have four or more dependants, rebate is only allowed for a
maximum of three dependants)

Page | 162
Question 13

Net Income Bracket Net Pay Gross Pay Tax Payable

25,650 – 49,700 35,000 47,385 6,960

49,700 – 157,700 85,000 128,833 25,210
157,700 + 140,000 220,500 47,210

Question 14

A.

K y/e 31 Dec 2013

Salary 1,740 45,240
Tax value of accommodation
(Medium cost in Area 1) 400 10,400
Motor vehicle 95 2,470
Entertainment allowance 100 2,600
Taxable income 2,066 60,710

B. K479.54 for y/e 31 Dec 2013 K12,390.04

C. Nil

Question 15

K
A. Salary 2,000
Tax value of accommodation 700
Cash allowance 250
Motor vehicle & petrol 125
Taxable income 3,075

B. Salary or wage tax payable: K663.44 (maximum of three dependants allowed).

Question 16

(K)
Gross tax on total income of K107,00 34,010
Less gross tax on salary income of K27, 000 4,460
Tax payable on non-salary income 29,550

Question 17

A. Gross tax on total income of K203, 500 72,610

Less: Gross tax on salary income of K57, 000 14,660
Tax payable on non-salary income 57,950

Page | 163
Question 18

This taxpayer incurred a non-salary loss of K11, 000.

Net taxable income is therefore K9, 000. Gross tax payable on K9, 00 =K0
Gross tax payable on K20, 000 = K2,360
Tax rebate due: K2,360

Question 19

A. Salary and wages tax paid throughout 2013

Gross tax payable on total income of K174, 000: 60,810

Less tax on salary income of K24, 000: 3,560
Tax payable on non-salary income 57,250
Less: 2007 Provincial tax paid (57,250)

Net tax payable/(refundable) NIL

Provisional tax of K57,250 was paid in 2013. As such no additional tax will be paid in 2014 in respect
of 2013 income (year in which 2013 tax return will be assessed).

Question 20

Taxable income: 80,000

Tax payable 23,210
Less dependent 1,050
22,160
Plus, provisional tax for 2013 22,160
44,320
Less provisional tax paid 21,000

23,320

Question 21

2013 X Y Z
Share of profits 25,800 25,800 25,800
Salary 34,000 40,000 36,000
Interest 4,400 3,600 4,600
Taxable Income 54,200 69,400 66,400
2014

Distribution: X Y Z
Share of Loss (8,200) (8,200) (8,200)
Salary 34,000 40,000 36,000
Interest 4,400 3,600 4,600
Taxation Income 30,200 35,400 32,400

Page | 164
Question 22

A. 3 – mother, sister attending high school and invalid brother (if officially certified)

B.
K
Salary (38,000 / 26) 1,461
Allowances: entertainment 200
Accommodation 55
Taxable salary income 1,716

C.
Allowable work-related expenses: (K)
Depreciation on computer and printer: K3, 000 x 30 % 900
(assume reducing balance method)
Computer software and maintenance: 350
1,250
Less 200
1,050
Rebate entitlement (assuming allowed): K1, 050 x 25% = K262.50

D.
Salary income:
Nominal salary 38,000
Cash allowance 5,200
Accommodation allowance 1,430
Total 44,630
Non-salary income:
Net business income 112,500

Gross tax total income of K157,130 (calculated per annual rates) 54,062.00
Tax on salary income of 44,630 (calculated per fortnightly table) 10,259.83
Less – dependent rebate (as calculated above) 1,050.00
Less – work expenses rebate (as calculated above) 262.50 8,947.33
Tax on non-salary income of K112, 500 45,114.67

E.
45,114.67 – 42,500 = K2,614.67 income tax payable by Peter for non-salary income.
Note also that Peter would be required to pay provisional tax for 2013 based on the non-salary
income derived in 2012. This amount has not been calculated for the purposes of this question.

Question 23

Non-salary income is K5, 000. Interest income should be grossed up to include 15% interest
withholding tax of K750 paid.
Gross tax on total income of K25, 000 K3,860
Less gross tax on salary income of K20, 000 2,360
Tax on non-salary income f K5, 000 1,500
Less credit for withholding tax earlier paid on interest 750
Net tax payable on non-salary income 750

Page | 165
Self-Assessment Test

Question 1

Personal income tax is: -

a) Applied at a flat rate.

b) Proportional.

c) Progressive.

d) Regressive.

Question 2

Salary and wage income is assessed to tax each:-

a) Year.

b) Month.

c) Fortnight.

d) Week.

Question 3

A rebate of tax of 25% is allowed for expenses incurred in earning salary and wages income to the
extent of: -

a) The first K200 of the expenses.

b) All but the first K200 of the expenses.

c) All the expenses incurred.

d) None of the expenses incurred.

Question 4

Lump sum superannuation payments are taxable at the marginal rate of 2% if: -

a) Accrued before 1 January 1993.

b) Contributions were made on behalf of the employee for greater than the 15 years.
c) Contributions were made on behalf of the employee for greater than the 7 years and they are aged
over 50 years at time of payment.

d) All of the above.

Page | 166
Question 5

Payments of salary and wages tax made in arrears, that is for work done in previous periods, are
taxable; -

a) Over the previous 26 fortnights.

b) In the fortnight they are received.

c) Cover the period that the work they refer to was done.

d) None of the above.

Question 6

The first K5, 000 of non-salary and wages income earned by an individual is taxable: -

a) At a rate of nil because of the K10,000 tax free threshold.

b) At the top marginal rate of 42%.

c) At the difference between the tax on salary income plus non-salary less tax deducted from the
employee’s salary and wages.

d) At the difference between that tax on salary income plus non-salary income less the tax on his or
her salary and wages tax income.

Question 7

Benefits that may be provided to an employee exempt from income tax include: -

a) Provision of vehicles, accommodation under an approved low-cost housing scheme and leave
fares.

b) Provision of private telephone leave fares and payment of school fees.

c) Provision of leave fares, entertainment allowance and payment of school fees.

d) Provision of accommodation under an approved low-cost housing scheme, leave fares and
payment of school fees.

Question 8

Lump sum superannuation payouts are

a) Not taxable.

b) Taxed at 2%.

c) Taxable as normal salary or wage income.

d) Taxable in respect of employer contribution and interest earned.

Page | 167
Question 9

Provisional tax is: -

a) Payable in respect of salary and non-salary income.

b) Payable in the same year as the income in question is earned.

c) Paid in three instalments during the year.

d) Is a first and final tax.

Question 10

A man with taxable income has three dependants.

a) He is entitled to an allowable deduction for these dependants.

b) He will automatically receive an allowance for these dependants.

c) He is entitled to a tax refund for these dependants.

d) He will normally be entitled to a rebate for these dependants.

Page | 168
Answers: Self-Assessment Test

Question 1

Answer c) Is correct. Income tax is progressive in most countries in the world. Taxpayers pay
proportionally more tax, the higher the income they earn, on the basis that those who earn more money
can afford to pay more tax.

Question 2

c) Is correct. Salary and wage income is assessed to tax each fortnight. It is a ‘first and final’ tax,
although the tax-free threshold for the year is K10,000.

Question 3

Answer b) Is correct. The first K200 expenses are excluded from the rebate and this is why tax
calculations as per the fortnightly) rates set out in the Papua New Guinea income tax legislation
always differ slightly from those provided in the calculation sheet circulated to all group employers
(and personal income tax table on page 2 of this unit). The fortnightly tables have the K200 rebate
incorporated in the rates, but this is not reflected in the personal income tax tables.

Question 4

d) Is correct. All these circumstances attract the concessional rate of tax.

Question 5

c) Is correct

Question 6

a) And b) Are fundamentally incorrect because tax on a person’s non-salary and wages income must
be worked by reference to his salary and wages income. If he is on a high salary, he will be taxed
more on the same investment income than a person who has very little salary and wages income. c)
Is incorrect, even though it looks logical, and d) Is the method that applies.

Question 7

d) Is the correct answer

Question 8

d) Is the correct answer

Question 9

a) Is incorrect because provisional tax is in respect of non-salary income. b) is the correct answer. It
is an advance tax payable on income in the same year as that income is being earned. c) is
incorrect as provisional tax is paid on one payment. D) is incorrect as it is not a first and final
tax, but rather a provisional tax based on an estimate of what taxable income for the year is likely
to be.

Page | 169
Question 10

a) And c) Is incorrect because a taxpayer is entitled to a tax rebate, not an allowable deduction or
refund, for dependants. b) Is incorrect because a salary and wages declaration from must be
completed before a rebate can be approved. d) Is the correct answer.

Page | 170
7 TAXATION OF COMPANIES AND OTHER ENTITIES

Learning Objectives

After you have successfully completed the work in this unit you should be able to:

• List commercial enterprises subject to company tax.

• Apply the resident company tax rate to calculate tax liability of companies.

• Apply the dividend (withholding) tax rate to calculate tax liability of companies.

• Explain the tax treatment of dividend income received by companies.

• Explain the tax treatment of dividend (withholding) tax paid on divided income received
by companies and individuals.

• Demonstrate how company tax is paid in instalments of provisional tax.

• Explain how the income of superannuation funds is taxed.

• Explain the nature of a trust and how trusts are taxed.

For the purpose of taxation most commercial bodies or associations are treated as companies
and are therefore subject to company tax. Thus, for example, companies, business groups and
superannuation funds pay company tax rates (although superannuation funds now pay a lower
tax rate). As you are already aware partnerships and sole trader firms do not pay company
tax. Instead the profits of these bodies are taxed at personal income tax rates in the hand of
the individual owners. Charitable, educational, religious and sporting associations and
registered trade unions are exempt from paying tax.

Companies must appoint a public officer who is the representative of the company in all its
dealings with the IRC. The public officer need not be an employee or shareholder of the
company (they could be from an accounting firm) but must be resident in Papua New Guinea.

Accounting Methods

The general rule for a company is that assessable income is derived on an accrual basis. That
is, income is normally taxable when earned rather than received. Thus, a cash basis of
returning income would not be acceptable for a company. However, some exceptions to the
rule are acceptable for particular business activities or types of income. For example, in
construction and engineering contracts, it is often acceptable for the profit (or taxable income
from the contract) to be reported and assessed for tax on completion of the contract. Also,
interest, dividends and rental income from investments are generally accepted as taxable when
received.

Page | 171
Taxable Business Profits

The taxable income for a trading business is determined by bringing to account as income the
proceeds of sales and deducting the cost of goods sold and other amounts allowable as
deductions.

Taxable income will not be exactly the same as the profit figure arrived at in a company’s
profit and loss statement. Allowances and deductions for tax purposes will differ in some
cases from normal accounting allowances and deductions. For example, as you already learnt,
provisions for future liabilities are normally not allowable. Also, depreciation is calculated at
certain specific rates for tax purposes. In practice it is usual for a company to start with the
profit figure in the company accounts and make a number of adjustments to arrive at taxable
income. In other words, a reconciliation statement is worked out, beginning with the
accounting profit figure and arriving at the taxable profit.

Company Tax Rates

Resident companies are taxed at a flat rate of 30%. The rate was increased from 25% from
January 2003 onwards. Non-resident companies are taxed at a higher rate, which shall be
considered later (Unit 8). Generally, resident companies are also liable to deduct dividend
withholding tax at the rate of 15% from dividends paid to shareholders. Profits distributed in
the form of dividends to shareholders are subject to this tax. The company paying dividends
must withhold this amount and pay it to the IRC by the twenty first day of the month following
payment of the dividend. Business groups, superannuation funds and a limited number of
others are not subject to dividend (withholding) tax.

Example

A company has a taxable income of K1, 200, 000.

Income subject to company tax 1,200,000

Less: company tax (30%) 360,000
840,000

If the company decides to distribute all its profits after tax, distributed profits are subject to
dividend withholding tax follows:

Gross amount distributed as dividends 840,000

Less dividend withholding tax (15%) 126,000
Net amount distributed as dividends 714,000

The effective rate of tax on distributed profits of resident companies is therefore 40.5%
(486,000/1,200,000 x 100).

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It is important to note that although a company paying a dividend has an obligation to deduct
dividend withholding tax, the liability to dividend withholding tax rests with the recipient.
Dividend withholding tax is basically a prepayment of tax by the recipient. Where the
dividend is paid to a resident individual (on or after 23 December 2005) or to a non-resident
the dividend (withholding) tax is a final tax. This means a dividend subject to PNG dividend
(withholding) tax and paid to a resident individual shareholder is exempt as it is not subject
to any further taxation in the hands of individual shareholders. The total tax on distributed
profits will be 40.5% (being 30% plus 15% of 70%).

If dividends are not distributed to shareholders, then no dividend withholding tax is payable.
Nor is there any requirement to distribute a proportion of profit. In some countries
undistributed profits are subject to a further tax. In Papua New Guinea although a company
may distribute no dividends, certain payments may be deemed to be divided payments and
subject to dividend withholding tax. This we shall consider later.

It is normal for a company to retain some of its profits after tax and distribute a certain amount
as dividends. Let us assume in the above example that the company distributed just K600,000
as dividends to shareholders:

Amount distributed as dividends 600,000

Less dividend (withholding) tax (15%) 90,000
Net amount distributed as dividends 510,000

You will notice that the recipient of dividends effectively receives just 85% of the dividends
paid (510,00/ 600,000 x 100).

Company tax rebate on dividend income (S.216)

Resident companies receive a full rebate of income tax on dividend income, so that, in effect,
no income tax is normally paid on dividends. The aim is to stop double taxing of dividends
as they pass through companies. The divided income is first included in the income of the
company to calculate gross tax payable. The rebate amount is then deducted to calculate net
tax payable.

Example

Net trading income of company K300,000

Dividends (gross) received 50,000
Taxable income 350,000
Income tax at 30% 105,000

Deduct:

Rebate on dividends received 50,000 x 30% 15,000

Tax payable 90,000

Dividend income received from overseas companies is similarly effectively tax-free when
received by resident companies.

A dividend rebate cannot reduce tax payable to less than nil. In other words, a company
cannot claim a loss and at the same time claim a dividend rebate. An excess dividend rebate
is forfeited if it cannot fully be used in the current year.

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Credit for Dividend (Withholding) Tax Paid (S.189E)

A resident company receives a credit for dividend (withholding) tax deducted from dividend
income received. A credit is given against withholding tax payable on accumulated dividend
income, which the company itself subsequently distributes. In the last example, the company
would actually have received net dividends of K42, 500. The sum of K7, 500 (17%) would
have been deducted as dividend withholding tax. The company would recover this amount
by claiming a credit against withholding tax on these (or other) dividends when distributed to
shareholders.

Example

A company receives, as part of its overall income, gross dividend income of K50, 000. The
net amount received has been K42, 500, since K7, 500 has been deducted as dividend
(withholding) tax. The company decides to distribute K120, 000 as dividends to shareholders.
Although the company has to remit K18, 000 to the IRC, it has a dividend (withholding) tax
credit in its Refundable Dividend (Withholding) Tax Account. Therefore, the balance in this
account reduces the remittance required as follows:

Dividend (withholding) tax K18, 000

Less Balance in Refundable Dividend (Withholding) Account 7, 500
Cash Payment to be remitted to IRC 10, 500

If the balance in the Refundable Dividend (Withholding) Account is not used up in one year,
it may be carried forward and used in a later year.

Credit to individuals for dividend (withholding) tax paid

A taxpayer who receives a dividend from a resident company prior to 23 December 2005 (the
date the 2006 Budget legislation was certified) is entitled to a credit for the dividend
(withholding) tax paid.

As noted above dividends received by an individual on or after that date, subject to dividend
(withholding) tax, are exempt. The credit for dividends received prior to 23 December 2005
will be lesser of:

• The actual dividend (withholding) tax paid, or

• The ‘average’ amount of tax payable on the dividend income.

The ‘average’ amount of tax payable on dividend income is calculated as follows:

Total PNG Tax Payable

x Gross Dividend Income
Total PNG Income

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Example

Salary income 45,000

Partnership income 100,000
Dividends (gross) 14,000
159,000
Assessment:
Gross tax on total income (159,000) 54,810
Less gross tax on salary income (45,000)
10,460
Tax on non-salary income 44,350

Credit on dividend (withholding) tax paid (S.219A)

61,480
x 14,000 = 5,413
159,000

Actual dividend (withholding) tax paid K14, 000 x 15% = 2,100

K2, 100 is the credit figure allowed because it is lower than K4,826.

How to calculate Gross Dividend Income

Companies must include the gross amount of dividends received as part of their assessable
income. This requirement also applies to individuals who received a dividend before 23
December 2005. Therefore, it is necessary to ‘gross up’ the net dividend received to bring to
account the dividend (withholding) tax portion. This is easily done once you remember that
net dividend income represents 85% of the actual dividend (100% - 15% = 85%).

Example

A company receives a net dividend of K11, 900. What will be the gross dividend figure to be
included in its tax return?

Dividend (withholding) tax was deducted at 15% prior to receiving the dividend.

Net dividend = K11, 900 = K85% of gross dividend

Gross dividend = ? = 100% of gross dividend
Therefore, Gross dividend = K11, 900 /.85 = K14, 000.

Dividend payments and Deemed Dividends (S144 & 145)

Certain payments, loans, gifts, etc. made by private companies* can be classified as deemed
dividends and become subject to income tax in the hands of the recipients. If the IRC
considers remuneration in the form of directors’ fees, loans, compensation, etc. to be
excessive, the excess so determined is deemed to be a dividend paid by the company. This
provision is mainly designed to prevent tax-free payments to directors and others in the form
of gifts or loans, which are never repaid. Details of any gifts, loans or other payments must
be provided (in statement no. 10) in the company tax return form.

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Example

A private company in its tax return calculated its taxable income to be K500,000. Included
in its expenses were certain payments, amounting to K150,000 which the IRC disallowed and
deemed to be dividends paid out of taxable profits. Taxable income was increased to
K650,000 in the assessment issued by the IRC. The payments of K150,000 were taxable as
normal income in the hands of the recipients.

*Private companies as described in the Income Tax Act. See end of this unit for definition of
private company.

Company Provisional Tax (S.275J – P)

In the year 1999 ‘provisional’ tax was introduced for companies. It was phased in over a
four-year period, and from 2003 onwards, completely replaced ‘notional’ tax. Provisional tax
is paid on taxable income in the same years as that income is earned. It is therefore based on
an estimate of how much profit will be made during the year. In the following year a tax
return will be submitted, and a final assessment issued. This will result in either additional
tax being payable, or a refund if too much provisional tax has been paid (provided no other
taxes are outstanding).

Provisional tax is payable in three quarterly instalments, on 30 April, 31 July and 31 October.
This tax is estimated on the tax assessed for the year proceeding the income year, increased
by a certain percentage amount. This amount, known as the uplift factor, is determined by
the IRC each year, usually 5%. Companies may, alternatively, estimate their own tax liability
for the year. However, there are penalties if the estimate is less than 75% of the actual tax
payable for the year. The IRC has the discretion to remit (cancel) additional tax.

Year of income and year of tax

For companies, the year of income refers to the year in which taxable income is derived. The
year of tax is the year following the year of income, which is (usually) the year in which a
company’s taxable income is finally assessed and this was also relevant under the former
“notional tax: system. For example, a company earns taxable income in 2012. The tax return
disclosing this income would be finally assessed in 2013 (assuming lodged on a or before 30
June 2013). In this case the year of income is 2012 and the year of tax is 2013. Rather
confusingly, company tax returns are labelled according to the year of tax, so the 2013
company tax return would refer to the 2012 year of income – to income derived in 2012.
Given the year of tax has no practical application, in this course you should assume at all times
that the year of income is being referred to.

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Taxation of Superannuation Funds

The net income of a resident superannuation fund is taxed in a similar manner to that of a
resident company, except that the tax rate is 25%. Dividends paid to a superannuation fund
qualify for the dividend rebate and are exempt from dividend (withholding) tax if the fund is
an authorised superannuation fund. Where an employer’s contributions to a superannuation
fund exceeds 15% of an employee’s fully taxed salary or wages, the excess contribution is
included as assessable income of the fund.

Example

A resident superannuation fund earned the following net income for the year:

• Interest income from financial institution 140,000

• Dividend income from resident companies 330,000
• Net rental income from ownership of commercial property 1,200,000
Net income 1,670,000

Dividend income would be exempt from dividend (withholding) tax. The fund would also be
entitled to the dividend rebate on dividend income so that, in effect, no tax would be payable
on the dividend income. the net rental income would be taxable at 25%. Net tax payable
would be K335, 000 calculated as follows:

Net income 1,670,000

Tax on net income 417,500
Less dividend rebate (330,000 @ 25%) 82,500
Tax payable for the year 335,000

Primary Industry companies: incentive company tax rate

In the 2004 budget, a special tax rate of 20% was introduced, to apply to major agricultural
projects (with capital cost of at least K5 million. This has been reduced to K1 million from 1
January 2006) started within three years (from 2004), to last for ten years. The project should
be located in an area in which primary production of the crop or the livestock proposed was
not previously carried out, or not previously carried out on a large scale.

Large scale tourism facilities: incentive company tax rate

The taxation rate applicable to the income derived by a taxpayer solely form a new large-scale
tourism facility or a substantially improved tourist accommodation facility will be 20% for
the 1st year in which such income is derived and for a maximum of 9 years thereafter. To
qualify the taxpayer must register with the Commissioner General, the expenditure must be
US$10 million or more on a hotel, motel, ship, inn or other short-term accommodation in
Papua New Guinea that provides 150 or more rooms for accommodation and construction of
the facility must commence between 1 January 2007 and 31 December 2011.

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Trusts (S.130-136)

A trust is an arrangement whereby trustees look after trust property on behalf of beneficiaries.
Trust property may be money or other assets. Trustees are the legal owners of the property
they are obliged to look after for the ‘beneficiaries’, who are said to have beneficial ownership
of the assets.

For tax purposes there are three types of trusts which we shall now consider.

The first type ‘normal’ trusts are general trusts, which are quite common in other countries.
Money is often ‘tied up’ in a complex trust structure, the main aims of a trust are asset
protection and to provide a simple mechanism to minimise income tax payable by splitting
income with family members. In Papua New Guinea, however, normal trusts are not popular
because of their tax treatment. Net income of a trust is taxed at 30%, payable by the trustee.
The taxation of beneficiaries depends upon whether there is a beneficiary or beneficiary who
is “presently entitle” to a share of the net income of the trust. The practical effect of the
provisions for resident beneficiaries is that the trustee pays tax on the income and the
beneficiaries would be further taxed when the income is distributed to the beneficiaries at the
relevant beneficiary’s marginal tax rate. Non-resident beneficiaries of trust income are subject
to tax on their share of the net income of the trust at the rate of 10%.

Unit trusts are which are established for the management of funds. In the PNG context a unit
trust would raise funds from investors (referred to as unitholders) and use those funds to
purchase major investments such as commercial property. Profits and dividends form these
investments represent the income earned by unit trusts. Small investors may invest in a unit
trust and in this way, they get an opportunity to invest (indirectly) in large companies and
receive a share of the profits by reference to the number of units they hold in the trust. The
Pacific Balanced Fund (formerly the Investment Corporation Fund) is an example of a unit
trust in Papua New Guinea. The net income derived by a unit trust is taxed at 30%. However,
the income s not further taxed in the hands of unit holders – the beneficiaries [S.29(I)(O)]. To
qualify for the concessional taxation treatment a unit trust must satisfy a number of conditions
including:

• It is required to spread its interments across a fairly wide area of investments.

• It must be a PNG resident.
• Its only undertaking is the investing of funds of the trust

Property Unit Trusts (“Puts”0 are trusts used to invest in real property.

Concessional tax treatment is available to PUTs. To qualify the PUT must be a resident of
PNG, and its only undertaking is investing funds of the trust. Funds invested must be not less
than K10m, and no less than 80% of the funds must be invested in property in PNG.

Where the concessional tax treatment applies the trustee is taxed at 30% and distributions to
unit holders are exempt from income tax. Although the taxation of property unit trusts is
relatively favourable, they have not been widely used as an investment vehicle in PNG. Two
important features of the tax treatment for property unit trusts are:

• Relaxing the ownership rules for property unit trusts and allowing property unit trusts
to invest outside PNG.

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• A reduced rate of stamp duty on the transfer of property to a property unit trust from 5%
to 2% where the transfer occurs within the two years from 1 January 2012 to 31
December 2014.

Landowner Resources Trusts (S.137 – S.142)

These trusts have been established to facilitate the receipt of income by landowners with
interests in resource projects, in particular in mining, petroleum and gas or timber projects.
Income derived from the project, such as an equity entitlement in a project, received by
landowner trusts will be subject to the normal company tax applicable to income from that
type of project. For example, income from a timber project would be subject to 30% company
tax. Income received from a petroleum project would be subject to the petroleum tax rate (see
Unit on Resource Projects). The beneficiaries, ie, landowners or incorporated land groups,
would not be subject to any further tax. Royalties received by a landowner resources trust,
which have already been subject to royalty withholding tax, are treated as exempt income and
thus not subject to further tax.

Case Study

XYZ Ltd is company incorporated in Papua New Guinea and is a manufacturer. The IRC
accepts that the company is a manufacturer for depreciation purposes. Two Papua New
Guinea citizens hold the entire issued share capital in ZYZ Ltd.

It had the following manufacturing activities

Gross Profit from manufacturing activities 1,370,000

Other Income
Dividends 100,000
Interest 25,000
Rental Income 62,300
Profit on sale of depreciable asset 17,500
Gain on sale of investment 20,000 224,800
Total Income 1,594,800
Less: Costs

Adverting 2,500
Bad Debts 6,900
Bank charges 220
Bank interest 129,800
Depreciation 79,136
Doubtful debts 35,000
Electricity 4,300
Exchange Losses (unrealised) 185,697
Education expenses 9,900
Freight 21,500
Insurance 8,450
Legal fees 6,100
Management fees 26,800
Rates & taxes 7,847
Repairs and maintenance 26,430
Rent 28,500

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Salary and wages 83,320
Security 600
Subscriptions 2,100
Superannuation (NASFUND) 4,500
Travelling 9,400
Vehicle expenses 18,800 698,800

Operating Profit before Tax K896,000

Other information:

1. The company had some surplus employee accommodation, which it rented out during
the year. Of the total repairs and maintenance expenses for the company during the year,
K6, 500 was applicable to the rental property. Included in this amount was an amount
of K2, 100 paid to a builder to repair a defective retaining wall on the property. The
company was impressed with the builder’s workmanship on the job and decided whilst
he was there, they would get him to extend the retaining wall and build a fence around
the property of this exercise, ignore any depreciation that may be claimable or fences or
retaining walls.

2. Subscriptions include membership to various social and sporting clubs in Port Moresby
for the General manager amounting to K1, 000. The GM argues that he predominantly
discusses business with existing and potential customers whilst having a beer and as
such it is a legitimate business deduction. The balance of the subscriptions claim is for
business journals and the Employers Federation annual subscription.

3. The profit on sale of the depreciable asst is the accounting profit on the sale of a
specialised piece of plant, the only one of its kind in Papua New Guinea. The actual tax
written down value of the asset at the time of disposal was Nil. Its original cost was
K15, 000. However, as another company was setting-up business as a competitor in the
same industry, they were willing to pay K17, 500 for this plant since it was going to take
them 6-7 months to import a similar item form overseas. As XYZ Ltd had a spare
machine, they though it was a good opportunity to order a new machine whilst getting
a good deal on the sale of one of their order machines.

4. Depreciation in the accounts has been calculated at the rates set by the IRC. However,
a new solar powered hot water system was purchased for the rental property and it was
installed ready for use on 1 October 2006. The cost of the new system was K3, 000 and
this was depreciated for accounts purposes at 10% on a pro-rata basis for the three
months until the end of the year.

5. Dividends in the accounts are net of tax. Amounts received were K85, 000 from a local
company after 15% Papua New Guinea DWT was deducted and K15, 000 from an
Australian company after deduction of 15% Australian DWT.

6. XYZ Ltd sold shares on 1 December 2012 which it held in ABC Company Ltd, an
investment it acquired 8 years ago for the purposes of obtaining a stream of dividend
income. The sale resulted in a gain on the disposal of K20, 000. The shares were
maintained in the balance sheet up to the point of sale at cost.

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7. Legal expenses include the following:

• Debt collection – K2,650

• Amendment to the company’s Constitution – K1,200
• Purchase of a subsidiary shelf company – K1,650
• Review of offer to purchase ABC Company Ltd shares from XYZ Ltd – K1,000

8. Movements in the provisions were as follows:

Balance as at Balance as at
01/01/2012 31/12/2012

Long Service Leave 14,800 20,000

Holiday Leave 6,500 5,500

9. XYZ Ltd has had a phenomenal year and thinks it has turned the corner into a profitable
era. However, it incurred the following tax losses in the previous years which have not
been claimed as deduction:

Year Ended Amount Cumulative

(Kina) (Kina)

31 December 2000 200,000 200,000

31 December 2001 180,000 380,000
31 December 2002 160,000 540,000
31 December 2003 140,000 680,000
31 December 2004 100,000 780,000
31 December 2005 80,000 860,000
31 December 2006 20,000 880,000
31 December 2007 20,000 900,000
31 December 2008 20,000 920,000
31 December 2009 30,000 950,000
31 December 2010 5,000 955,000

10. Except for the solar hot water system, the written down value of depreciable plant as at
31 December 2006, after using the ordinary depreciation rates set by the IRC, was
K100,000. All plant and equipment have effective lives greater than 5 years.

You are required to:

• Calculate XYZ Ltd’s taxable income for the year ended 31 December 2006, and
• Calculate XYZ Ltd’s tax payable in respect of that taxable income.

Case Study Solution

Operating Profit Before Tax 896,000

Add: Non-deductible/Assessable Item

• DWT – Papua New Guinea Dividend 15,000

• DWT – Australian dividend 3,000
• Doubtful Debts 35,000

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• Exchange Losses (Unrealised) 185,697
• Repairs & Maintenance – retaining wall and fence 4,400
• Club membership 1,000
• Legal fees 3,850
• Increase in provision for long service leave 5,200 253,147
1,149,147

Deduct: Deductible/Non-Assessable Items

• Profit on sale of depreciable asset (account) 2,500

• Gain on sale of investment 20,000
• 100% claim on Solar Hot Water System 2,925
• Reduction in holiday leave provision 955,000
• Carried Forward tax losses 100,000 1,081,425

Taxable Income 69,722

Tax thereon at 30% 20,916.60

Less:
Section 216 Dividend Rebate (120,00 x 30%)
- Limited to tax payable 20,916.60
- Tax Payable Nil

Case Study (Solution Notes)

1. Construction of the retaining wall and fence is capital and therefore, not deductible under
Section 68(I)

2. Club subscriptions are specifically non-deductible (Section 68 AB). This is regardless

of how much business may or may not be transacted at such a facility.

3. Cost of plant K15, 000

Tax WDV at time of disposal Nil

Consideration received K17, 500
Recouped depreciation [Section 75(2)] K15, 000
Non-assessable capital profit K 2, 500

4. 100% deduction allowed (Section 68A) 3,000

Less depreciation already claimed (3,000 x3/12 x 10% 75
Additional amount claimable K2,925

5. Sale of investment is not assessable under Section 46 since it was a one-off type capital
gain. The sale would not be assessable under Section 47(I), as the shares were not
acquired with profit making by sale intentions.

6. Only legal fees incurred on debt collection are deductible under Section 68. The balance
of legal expenses are all capital in nature and therefor, not deductible.

7. A deduction is not allowable for these provisions until paid [Section 68(3)].

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8. Losses can now be carried forward for twenty years. However, losses which would have
been written off under the previous 7-year limit prior to the changes in the law cannot
be reinstated. This means losses incurred prior to 1994 cannot be claimed. As the losses
were incurred after 1994 the full amount carried forward as at 31 December 2006 of
K995,000 is eligible to be claimed against assessable income for the 2006 year.
Accordingly, the total tax losses of K955,000 have been utilised during the 2006 year of
income.

9. Additional depreciation available for “industrial plant” [Sections 73(2), (7)].

10. Section 216 Dividend Rebate

PNG dividend (gross) 100,000

Australian dividend (gross) 20,000
120,000
Average Tax Rate x 30%
Dividend Rebate = K 36,000

Page | 183
Self-Assessment Exercises

Question 1

A company has a taxable income of K250, 000. It distributes dividends during the year of
K130, 000.

Calculate company tax ad dividend withholding tax payable.

Question 2

A company has assessable income of K500, 000 for the year. Allowable deductions amount
of K280, 000. It distributes dividends to shareholders equal to 60% of net after tax income.
The dividends were distributed as interim dividends in May and final dividends in December.
Calculate:

A. Company tax
B. Net income after tax
C. Dividend withholding tax payable
D. State when the dividend withholding tax was paid to the IRC

Question 3

A company earned the following income:

Net training income K2,500,000
Interest received from PNG bank 50,000
Gross dividends received 100, 000

A. Calculate company tax payable

B. What credits is the company entitled to receive?

Question 4

A company received net dividends of K210, 280.50

A. Calculate gross dividend income to be included as assessable income in its tax return
B. Calculate tax payable on this income
C. Calculate any credit entitlements

Question 5

A taxpayer earning a salary of K60, 000 per year also received net dividends of
K12, 995 during the year ended December 2012.

Calculate tax payable on the dividends received.

Question 6

In the year 2012, taxable income of a company is estimated to be K2.5 million. Its actual
taxable income is in the end assessed at K2.6 million.

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State what tax payments are likely to be made in respect of this income, and when they would
be made.

Question 7

A company, in its final tax return for 2007, declared net trading income to be K800,000. Net
dividends received were K6, 375. The IRC disallowed certain payments amounting to K5,
000. The company also distributed dividends of K300,000 to shareholders.

Calculate.

A. Taxable income
B. Company tax payment
C. Net dividend (withholding) tax payable to IRC

Question 8

XYZ Company Ltd issued the following income statement in 2012.

Sales 150,000
Cost of goods sold 65,000
Gross profit 85,000

Other Income:
Rental income 12,000
Bank interest 5,000
Profit from sale of vehicle 8,000 25,000
110,000
Less: Costs
Wages 25,000
Advertising 4,500
Vehicle running expenses 7,000
Net discounts 700
Depreciation 7,200
Doubtful debts 500
Insurance 400
Net profit (before tax 800 46,100
63,900

Other information:

1. Profit from sale of vehicle: Sale price 20, 000; cost price 18,000; written down value
12,000
2. Wages include K7, 500 paid to a full-time training officer.

3. Depreciation relates to equipment purchased at the end of June 2001. Cost price K120,
000. Depreciation is calculated at 12% straight line. The prescribed rate for tax
purposes is 7.5% straight line. The business is also allowed to claim accelerated
depreciation of 20% of the cost of the equipment.

4. Losses carried forward K12, 700.

Page | 185
Answers to Self-Assessment Exercises

Question 1

Company tax – K75, 000

Dividend withholding tax – K19, 500

Question 2

A. Company tax – K66,000

B. Net income after tax – K154,000
C. Dividend withholding tax – K13,860
D. Dividend withholding tax paid to IRC before 21 June and 21 January of the
following year.

Question 3

A. K735, 000
B. Credit of K17, 000 deducted from dividend (withholding) tax payable on
dividends received. This is a credit against dividend (withholding) tax payable
on future dividends paid by the company.

Question 4

A. K210, 280.50 x 100/85 = K247, 389

B. The tax payable on dividend income is K74,217 and this is reduced to nil by the
dividend rebate, which is also K74, 217.
C. Entitled to credit for dividend (withholding) tax amounting to K37, 108.35
against dividend (withholding) tax payable on future dividends paid by the
company.

Question 5

A. Gross dividend income: K21, 995/.85 = K25, 876

Dividend (withholding) tax paid: 3,881

Gross tax on total income (86,500) 21,325

Gross tax on salary income (60,000) 15,710
Tax on non-salary (dividend) income 5,615

Credit on Dividend (withholding tax) paid (Sec.219A

21,325
𝑥 15,288 = 4,330
75,288

Actual Dividend (withholding) tax paid 15,288 @ 15% = 2,293

K2,293 is the credit figure allowed because it is lower than K4,330

Page | 186
Question 6

Provisional tax payments, each amounting to K250, 000 should be made at the end of April,
July and October 2006. In 2007 or later, once the final tax assessment for the company was
issued, a further payment of K30, 000 would have to be made.

Question 7

Taxable income:
Trading income: 800,000 + 5,000 (disallowed expenses) K805, 000
Gross dividends: 6,375/.85
7,500
Total 812,500

B. 812,500 x 30%
243,750
Less rebate for dividend income 2,250
Company tax payable 241,500

C. Dividend (withholding) tax payable on K300, 000 = K51,000

Less credit for dividend (withholding) tax paid on gross
dividend income of K7,500 1,125
Net dividend (withholding) tax payable 49,875

Question 8

Net profit as per Profit & Loss Statement 63,900

Add: non-deductible/Assessable items

• Depreciation 7,200

• Doubtful debts 400

71,500

Deduct: Deductible/Non-Assessable items

• Profit (capital) from sale of vehicle 2,000

• Wages – training officer 7,500
• Depreciation 4,500
• Accelerated depreciation 24,000
• Losses carried forward 12,700
50,700
Taxable income 20,800

Page | 187
Self-Assessment Test

Question 1

A company, which has never paid or received a dividend before, receives as cash dividend of
K85,000 from a subsidiary. It now declares a dividend to its shareholders of the same amount
as was declared in its favour and it will pay dividend withholding tax to the IRC of:

a) Nil

b) K17,000

c) K83,000 x 15%

d) K17,00 x 15%

Question 2

A company with a credit available of K13,000 in its refundable dividend withholding tax
account intends to declare a dividend of K100,000 to its shareholders. The dividend
withholding tax it actually has to pay to the IRC in due course is:

a) K2,000

b) K13,000

c) K17,000

d) None

Question 3

Included in a company’s income was K19,550 dividend income (net of DWT). The company
would normally be entitled to receive:

a) Credit of K3,245 for DWT paid

b) Rebate of K5,727 for tax payable on dividend income

c) Rebate of K3,000 for tax payable on dividend income

d) Credit of K3,450 for DWT

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Question 4

A resident individual receives dividend income of K76,500 on 1 February 2013 (net of DWT)

a) Gross dividend is K87,399

b) Tax payable is K12,699

c) Tax payable is K15,300

d) The DWT applicable to the dividend is K13,500 and the dividend income is exempt
from further tax.

Question 5

Taxable income for a company in 2006 is estimated by IRC to be K7.5 million. Taxable
income for the company is finally assessed by IRC at K6 million. The company will pay:

a) K6 million when its return is finally assessed

b) K1.8 million when its return is finally assessed

c) K2.5 million in provisional tax in April 2006

d) K750,000 in provisional tax in July 2006

Question 6

A senior manager and sole shareholder of a company received an interest free loan of K2
million from the company with no set repayment conditions. The IRC deemed the payment
to be a dividend payment from the company.

The senior manager would be:

a) Taxed on the payment at normal personal income tax rates

b) Taxed on the payment at 17% since it is deemed to be a dividend

c) Entitled to a credit for DWT withheld

d) Be taxed on the payment at 30%

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Question 7

Beneficiaries of a trust in PNG are:

a) Taxable on any distributions

b) Exempt on any distributions

c) May be either taxable or exempt depending on the status of the trust form which they
derive income

d) None of the above

Question 8

The purpose of a unit trust is to:

a) Allow distributions to non-residents

b) Allow landowners to take an interest in resource projects

c) Ensure that beneficiaries are not taxable in their distributions

d) Provide an opportunity for investors to participate in different investments

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Answers: Self-Assessment Test

Question 1

a) is correct because the company’s liability to deduct dividend withholding tax from the
dividend it is to pay to its shareholders is offset by the dividend withholding tax that has been
deducted from the dividend it received. In the circumstances described its liability to deduct
dividend withholding tax is exactly offset by the dividend withholding tax deducted from it.
b) is the right amount but he offset credit referred to means that the dividend withholding tax
of 17% does not have to be paid every time there is another dividend through a chain of
companies. c) and d) are numerically incorrect in any event.

Question 2

a) is correct because there is K17,000 due on the dividend declared by the company but it has
a credit available in tis refundable dividend withholding tax account of K13,000 which will
reduce the amount payable to K4,000.

Question 3

Divided income received would be K23,000 (grossed up). Credit/rebate for DWT paid is
K3,910. d) is therefore the correct answer. The rebate for tax payable on dividend income
would be K6,900 (K23,000 x 30%).

Question 4

Gross dividend received is K90,000, out of which K15,300 DWT is deducted. As the dividend
is received after 23 December 2005 and was subject to DWT the dividend is exempt from
further tax. d) is therefore correct.

Question 5

The company will pay provisional tax of K2.25 million (30% of K7.5 million) in three
instalments in 2005, each instalment being K750,000. d) is therefore correct. When its final
return is assessed it will be entitled to refund or credit of K450,000. a) and b) are therefore
incorrect.

Question 6

a) Is correct. The payment, being a dividend, would be taxed as normal income in the hands
of the individual. There would be no entitlement to a credit for DWT since no DWT would
have been withheld form the payment in the first place. This is the case even if the amount is
deemed to be a dividend after 23 December 2005 as amounts deemed to be dividends are
specifically excluded from the DWT provisions (refer section 144A and section 145). As the
deemed dividend is not subject to DWT the individual could not claim the exemption for
dividend income as it only applies to dividends which have been subject to DWT.

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Question 7

c) is the correct answer. A distribution from a normal trust is taxable to a beneficiary to

answer. b) is not always right and a distribution from a unit or landowner resources trust is
exempt in the hands of the beneficiaries so answer a) is not always right either. Answer d)
cannot be right.

Question 8

d) is the correct answer. a) and c) are incorrect and b) sets out the reason for provisions
relating to landowner resource trusts, not unit trusts.

Appendix: Section 144 (I) Definition of “private company” (see page 8) “private
company” means a private company in relation to a year of income where:

(a) At any time during the year of income, one person or persons not more than 20 in number
held, or had the right to acquire or become the holder or holders of, shares representing
not less than 50% of the paid-up capital of the company; other than capital represented
by share entitled to a fixed rate of divided only; or

(b) At any time during the year of income, not less than 50% of the voting power in the
company was capable of being exercised by one person or persons not more than 20 in
number: or

(c) Not less than 50% of:

(i) The amount of any dividend paid by the company during the year of income; or

(ii) If more than one dividend was paid by the company during the year of income, the
total amount of all the dividends paid by the company during the year of income
was paid to one person or to persons not more than 20 in number; or

(iii) A dividend was not paid by the company during the year of income, but the
Commissioner General is of the opinion that, if a dividend had been paid by the
company at any time during the year of income, not less than 50% of the amount
of that dividend would have been paid to one person or persons not more than 20
in number,

does not include a company which is controlled by another company which does not
satisfy any of the foregoing conditions.

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8 TAXATION OF NON-RESIDENTS AND OVERSEAS INCOME

Learning Objectives

After you have successfully completed the work in this unit you should be able to:

• apply the individual tax rates for non-resident income earners.

• calculate entitlement to credit relief for foreign tax paid on overseas income for:

➢ resident individuals

➢ resident companies

• explain the tax treatment of overseas losses

• apply company tax rates for no-resident companies

• explain the tax treatment of the following payments to non-residents-

➢ management fees

➢ royalties

➢ payment to insurers

➢ payments to shipowners or charterers

➢ interest, dividend and lease payment

• explain tax avoidance measures available to combat transfer pricing

• explain the reasons for international double tax agreements

• describe features of Papua New Guinea international tax agreements with respect to
certain forms of income to non-residents.

Taxation of Non-Residents

You already learnt that a non-resident for tax purposes is, in broad terms, someone who
spends, or intends to spend, less than six months in the country in the year.

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The personal income tax rates for non-resident individuals have not changed since 1 January
2008 and are as follows:

Taxable Income Tax thereon Rates of tax on excess

(K) (%)
Nil Nil 22
18,000 3,960 30
33,000 8,460 35
70,000 21,410 40
250,000 93,410 42

The personal income tax rates for non-resident individuals which were applicable from 1
January 2007 to 31 December 2007 were:

Taxable Income Tax Thereon Rates of tax on excess (%)

(K)
Nil Nil 22
18,000 4,500 30
33,000 9,000 35
70,000 21,590 40
250,000 93,590 42

Non-residents are not entitled to depend rebates.

Example

A New Zealand engineer spent four months in the country during the 2012 year and earned
K325, 000 for carrying out consultancy work. He would be taxed as follows:

Tax on (K325, 000 – K250, 00) @ 42% = 31,500

Plus = 93,410
Gross tax payable = 124,910

Non-residents are taxed on PNG income only. Income derived outside PNG is exempt
(Section 36).

Taxation of Foreign Income Received by Residents (Section 219)

In PNG, residents are taxed on their worldwide income. Resident taxpayers are allowed credit
for foreign taxes paid on foreign sources income. These taxes include taxes on dividends,
interest and rental income. The amount of credit a taxpayer is entitled to receive in respect of
foreign tax paid on overseas income is the lesser of:

• the actual amount of tax paid in the foreign country or

• the tax payable on foreign income at Papua New Guinea tax rates

The calculation of credit relief for foreign tax paid on overseas income involves the following
four steps:

1. calculate total taxable income (Papua New Guinea and overseas)

2. calculate total tax payable
3. calculate the Papua New Guinea tax application to the overseas income by using the
formula:

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 Total Tax Payable
x Overseas Income
Total taxable Income

4. Claim credit for the lesser of the foreign tax actually paid or the Papua New Guinea tax
payable – the amount calculated using the formula in Step 3.

Example

A taxpayer earned the following income during the year 2013.

• salary income
76,000
• non-salary Papua New Guinea income 72,000
• income from Australia (gross) 52,000
• income from Singapore (gross) 84,000

On his income from Australia it is assumed he paid the equivalent of K24,440 as tax in
Australia, and the equivalent of K18,650 as tax on the income from Singapore.

The tax credit relief would be calculated as follows:

Step 1 Calculate Taxable Income

• salary income 76,000

• non-salary local income 72,000
• income from Australia 52,000
• income from Singapore 84,000
• total taxable income in Papua New Guinea 284,000

Step 2 Calculate total tax payable and tax on non-salary income

gross tax payable on total income 105,490

less gross tax payable on salary income 21,610
tax payable on non-salary income (208,000) 83,880

Step 3 Calculate the Papua New Guinea tax applicable to overseas income using the
formula on the last page. This formula calculates the amount of tax payable at the
average rate of tax paid. The average rate of tax payable in this case is

105,490
x 100 = 37.4%
284,000

A separate calculation is required for each individual overseas receipt on which tax has been
withheld.

Therefore, for the Australian Income - 52,000 x 37.14 % = 19,312.80

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K19,312.80 represents the Papua New Guinea tax payable on the K52,000 of Australian
source income. This is the amount of tax this foreign income would attract Papua New
Guinea. The credit relief is therefore the lesser of the two: K19,312.80 or K24,440; in this
case – K19,312.80. This taxpayer will therefore receive a credit for the Papua New Guinea
tax payable.

For the Singapore income - 84,000 x 37.17 % = K31,197.60

Credit relief is limited to the lesser of the two: K18,650 paid as tax in Singapore of
K31,197.60 which is the Papua New Guinea tax payable. The credit relief in this case is
K18,650 being the lesser of the two.

Foreign tax cannot reduce tax payable to less than nil. Excess foreign tax credit is forfeited
(i.e. they cannot be carried forward like losses) if they cannot be fully used in the current year.

Franked and Unfranked Dividends

There is no distinction made between franked and unfranked dividends received from
overseas by individuals. In other words, a Papua New Guinea resident would not be entitled
to a credit for company tax paid in the country where the dividends were issued. A ‘franked’
dividend is one in which the recipient is entitled to receive a credit for the company tax paid
on the income which gives rise to the dividend. A credit would be allowed in respect of
foreign dividend withholding tax.

Foreign Tax Credit Relief for Companies (Section 219)

The amount of credit relief that is company which paid tax on overseas income (other than
dividends) is entitled to is the lesser of:

• the actual foreign tax paid

• the amount of tax liable to be paid at Papua New Guinea tax rates.

Example

A Papua New Guinea resident company earns Papua New Guinea income of K1 million. It
also earns foreign business income of K200,000. Foreign tax paid on this income was
K120,000.

The foreign tax credit is calculated as follows:

- Papua New Guinea company tax payable on K200,000 @ 30% K 60,000

- Foreign tax paid on K200,000 K120,000
- Credit relief will be the lesser figure, which is the PNG
Company tax payable K 60,000

Therefore, net Papua New Guinea tax payable on total worldwide income will be:

1,200,000 x 30% = 360,000

Less Papua New Guinea tax payable on foreign income 60,000
Net Papua New Guinea tax payable 300,000

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In this case the credit is limited to K60,000. As the company has already paid K120,000 of
foreign tax on its overseas income the additional tax cost of deriving the income outside PNG
is K60,000.

Foreign Dividends Received by Resident Companies

The tax treatment of foreign dividends received by resident companies is the same as domestic
dividends, i.e.; they are in the effect, not taxable. Gross dividend income is first included in
the company’s income to calculate gross tax payable. Then a rebate is calculated for tax
payable on dividend income (less direct expenses incurred in deriving the income) which is
included in taxable income. The amount of the rebate is subtracted from gross tax payable to
arrive at net tax payable.

Overseas Losses (Section 66A (3))

Losses incurred in deriving income with a source outside PNG are not deductible from PNG
source income. However, expenses incurred in connection with export market development,
if incurred outside the country, may be accumulated and offset against any overseas income
earned.

Example

A Papua New Guinea company declared the following income figures:

Year 1
Papua New Guinea Income K Overseas Income K
Papua New Guinea income 14.5 m Australian income 3.7m
New Zealand income 5.4m (loss)

Net taxable worldwide income 14.5

Papua New Guinea tax payable
14.5m x 30% = 4.35m
Overseas Losses carried forward: 2m

Year 2
Papua New Guinea K Overseas Income K
Papua New Guinea taxable income 9.5m Australian income 4.5m
New Zealand income 2.7m
Net taxable worldwide income
Papua New Guinea taxable income 9.5m
Overseas income 7.2m
Less: losses carried forward 2.0m 5.2m
14.7m
Tax payable 14.7m x 30% = 4.41m

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Taxation of Foreign Companies in Papua New Guinea

Taxation of Branches of Foreign Companies [Rates Act (Sch.4.2)]

The taxable income of a Papua New Guinea branch of a foreign company is calculated in
much the same way as that of a locally incorporated company, with some minor differences.
Most foreign investors, however, other than those on short-term projects, prefer to set up a
locally incorporated subsidiary rather than a branch. The main reason is because the company
income tax payable by a branch is significantly higher than that payable by a subsidiary – 48%
instead of 30%.

No dividend (withholding) tax is payable, however, by a branch of a foreign company on its

branch profits.

The following figures show how the profits of a branch of a foreign company are taxed in
comparison with a local incorporated company.

Example

Branch of Foreign Company Local Company

Assessable income 500 500
Less Allowable Deductions 250 250
Tax rate 48% 30%
Tax payable 120 75
After tax profits 130 175
Assume all profits are distributed
Less: Dividend (withholding) tax Nil 26.25*
Net income after taxes 130 148.75
Effective tax rate 48% 42% (approx.)

*The exact rate of tax on dividends distributed will depend on the treatment of the dividend
in the jurisdiction of the shareholder.

Foreign Contractor Tax (FCT) (Section 196A – 196F)

This tax is applicable to overseas companies or individuals (where the earnings of the
individual are not salary and wages) entering into contracts (referred to as a “prescribe
contract”) with resident companies or residents and which involves installation and
construction or providing consultancy services in Papua New Guinea. Income derived from
a prescribed contract is deemed to be derived from a source within Papua New Guinea. The
resident principal acts as the IRC’s agent for collecting the tax. Specifically, the tax applies
to contracts in connection with:

• the installation, maintenance or use in Papua New Guinea of substantial equipment or

machinery.

• the construction in Papua New Guinea of structural improvements or other works

including:

➢ the construction of roads, including bridges, culverts or similar works forming part
of a road.

➢ the erection of buildings, fences or similar improvements.

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 ➢ the clearing or draining of land.

➢ the construction of facilities for the provision of water, light, power or

communication.

➢ the provision or improvement of transport facilities of any king

• The use in Papua New Guinea of any industrial, commercial or scientific equipment
(fixed or not) and any vehicle, shipping vessel or aircraft. This includes lease and charter
payments.

• The provision in Papua New Guinea of professional services or services as an adviser,

consultant or manager. This excludes individual consultants who would generally be
liable to salary or wages tax. The IRC should be consulted if there is any doubt about
this.

Example

Gross income of foreign contractor from Papua New Guinea sources: K500,000

Taxable income 500,000 x 25% = 125,000

Tax payable 125,000 x 48% = 60,000
The tax payable is effectively 12% of K500,000 = 60,000

The withholding tax at the rate of 12% of gross income is a first and final tax and there is no
requirement to lodge an income tax return. If the actual taxable income derived from the
contract is less than 25% of gross income, the foreign contractor can request the right to lodge
an income tax return so that they return income on the basis of actual income and expenditure
and are then assessed on the actual taxable income. However, the IRC does not have to accept
the return.

If the return is accepted, then credit will be allowed for any withholding tax already paid.
There are limits to the amount allowable for administrative and management expenses (not
directly connected with the contract) incurred outside Papua New Guinea. The amount
allowable should not exceed the lesser of:

• 5% of gross income from the contract; or

• the same proportion of the worldwide general administration and management expenses
as the gross income from the contract bears to the worldwide income.

Example

A foreign contractor earns K8m gross from a Papua New Guinea contract. Its worldwide
gross income is K200m. Worldwide general administration and management expenses
amount to K12m. The amount of total administration and management expenses attributed to
the Papua New Guinea contract may not exceed the lesser of:

• 5% of gross income from the contract: 8m x 5% = 400,000 or;

• same proportion of total expenses as Papua New Guinea income bears to worldwide
income.

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Papua New Guinea income of K8m is 4% of worldwide income of K200m. Therefore,
administration and management expenses incurred overseas claimable against Papua New
Guinea income may not exceed 4% of K12m, i.e. K480,000.

The amount claimable may not exceed the lesser of K400,000 or K480,000 i.e. K400,000.

A resident who has entered into a contract with a foreign contractor must not make a payment
under the contract until such time as the IRC has been advised of the income tax payment
arrangement. Once advised that FCT is to be deducted from contract payments, the resident
must remit the tax deducted from payments to the IRC within 21 days following the month in
which a payment was made by the foreign contractor.

Residents making payments to a foreign contractor without written confirmation from the IRC
that the foreign contractor has made arrangements to pay Papua New Guinea tax are guilty of
an offence which carries a maximum penalty equal to the tax payable by the foreign
contractor.

Employees of the Foreign Contractor

The salary or wages of employees of a foreign contractor working in PNG are deemed to be
derived from a source in PNG. This means the income derived while they are working in
PNG is subject to salary or wages tax in PNG.

The foreign contractor is required to register as a group employer, deduct and remit to the IRC
the applicable salary or wages tax, and otherwise comply with all the other duties imposed on
a group employer under the Act.

Foreign contractors are also liable to lodge a training levy return. This is required even if they
do not lodge an income tax return.

Management Fees (Section 68AD)

We have already considered briefly the treatment of management fees in Unit 4, which deals
with specific allowable deductions. The payment of management fees is fully allowable when
payment is made to a third party or non -associated business.

However, there are restrictions in section 68AD imposed on management fees paid to an
‘associate’. The term associate is defined in section 4(i) of the Income Tax Act and in the
context of companies means a company which is controlled by the same shareholders (i.e.,
50% or more of the company is owned by the same person or persons).

These provisions are, in particular, aimed at payments overseas by PNG branches of overseas
companies or by a PNG subsidiary of a foreign company. The aim is to reduce the possibility
of transfer pricing (sometimes referred to as ‘profit shifting’) between a resident and an
overseas related party.

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Note that, following an amendment in 2005 Budget, there is a greater limitation on deductions
for management fees (paid to related businesses). In addition, the meaning of the term
management fees was changed and is now defined as:

“Management fee” means a payment of any kind to any person, other than to an
employee of the person making the payment and other than in the way of royalty, in
consideration for any services of a technical or managerial nature and includes
payment for consultancy services, to the extend the Commissioner is satisfied those
consultancy services are of a managerial nature.

The formula, which determines the deductibility of management fees payable to associates, is
as follows:

payments are allowed up to the limit of A or B – whichever is greater-

(A) 2% of the assessable income derived from Papua New Guinea sources by the taxpayer
or.

(B) 2% of the total allowable deductions (excluding the management fees) incurred by the
taxpayer in PNG

To the extent management fees are deductible under this Section, the source country in which
the management fees are derived is deemed to be Papua New Guinea.

Example

ABC (PNG) is a subsidiary of ABC (International). Figures for ABC (PNG)

Sales income K500,00

Allowable deductions (excluding management fees) K300,000
Management fees to ABC (international) K150,000
Determination of deduction limit for management fees of K150,000

2% of assessable income 100,000

or 2% of total allowable deductions (2% of 3m) 60,000
(excluding management fees)
The greater of 60,000 or 100,000 100,000

Therefore 100,000 of 150,000 management fees paid to the parent company would be
allowable.

The IRC may waive (not insist on) the limits set on in section 68AD if it is satisfied the
payments are not made to an associate for the purpose of tax avoidance. There is also no
limitation of the deductibility of management fees paid to associate companies where as a
result there is no reduction in the amount of income tax payable within Papua New Guinea;
for example, where the allowable deduction for management fees paid by one company is
offset by increased taxable income in PNG of another company because of the receipt of
management fees.

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Management Fees Withholding Tax (Section 196F – W)

A 17% withholding tax applies to management fees paid to non-residents. Although the
withholding tax only applies to the amount actually allowable as a tax deduction it applies
whether or not the management fees are paid to an associate.

In the above example the amount withheld would be 17% of 500,000 (not 750,000) = 85,000.

The withholding tax does not apply to residents of some countries with which Papua New
Guinea has double tax agreements (e.g. Australia, China and Singapore), provided they are
for services which are undertaken in those other countries.

The tax must be remitted to the IRC 21 days after the month in which the management fees
are paid or credited.

Royalty Withholding Tax (Section 357)

A royalty is basically a payment for the right to use knowledge. It is defined (Section 4) to
include payments in return for:

• the use of, or right to use, any copyright, patent, design or model, plan, secret formula
or process, trademark or other like property or right.

• supply of scientific, technical, industrial or commercial knowledge or information.

• a total or partial forbearance (prevention) in regard to the use or supply of the rights in
the above two categories. (This definition of royalties was designed to prevent tax being
avoided by arrangements under which, instead of amounts being payable for the
exclusive right to use property, it is agreed that payments will be made for an
undertaking that rights to use the property will not be granted to anyone else.)

When a person or company pays or credits a royalty to a non-resident, they should deduct
from the royalty:

• 30% of the gross amount of the royalty, where the recipient is an ‘associate person’, e.g.
a relative, partner or company under common ownership. Sometimes double taxation
agreements entered into with other countries may limit royalty withholding tax to a
lesser amount, usually 10%.

• 10% of the gross amount of the royalty, where the recipient is not an associated person.
A non-associated person may alternatively lodge an income tax return disclosing
expenses incurred in earning their royalty income and be taxed on the net amount at the
rate of 48% (or at non-resident personal tax rates if not a company).

Lower withholding taxes may be agreed to in certain double taxation agreements. Royalty
withholding tax is due and payable within 21 days following the month in which it was
collected.

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Example

XYZ (PNG) is a subsidiary of XYZ (NZ). During the year of income, it pays royalty fees of
K800,000 to Australia for the use of advertising material developed by its Australian parent
XYZ (NZ).

XYZ (PNG) also makes royalty payments of K400,000 to ABC (Aust), a non-associated
company. ABC subsequently submits a tax return to the IRC declaring expenses to be
K320,000 in relation to the royalties received.

Royalty withholding tax payable on payments of K800,000 to XYZ (NZ) will be:

K800,000 x 30% = K240,000

Tax payable by ABC (Aust) on net royalty income of K80,000 is

K80,000 x 48% = K38,400

This is less than 10% of gross royalty income of K400,000.

The paying company must remit the tax withheld to the IRC unless the non-resident company
makes arrangements to the satisfaction of the IRC to file an annual tax return and to pay any
taxes that may be assessed.

No withholding tax is levied on royalty payments to resident companies.

Non-Resident Insurers (Section 202-209)

If a PNG company pays premiums to a non-resident insurer where the insured risk relates to
property situated in PNG at the time of the contract or an insured event which can only occur
in PNG, the non-resident insurer is liable to pay PNG income tax at 48% (or 25% in the case
of unincorporated associations) on the net profit from the premiums. In other words, tax
amounts to 4.8% of the premium. However, if the non-resident insurer elects to produce
details of the profit of the insurance contract, that figure instead of the premium may be used
as the tax base, taxable at 48%.

Example

A PNG incorporate shipping company pays a premium of K75,000 to Marine Insurers Ltd
(UK) in respect of a vessel operating in PNG waters. Amount withheld and payable to the
IRC would be:

75,000 x 10% = 7,500 – notional taxable income

7,500 x 48% = 3,600 tax payable

If Marine Insurers elected for taxable income to be based on actual premium income and
expenses, and these consisted of:

General expenses 1,750

Compensation payout 68,000
69,750

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Net income from the insurance contract would be:

Premium income 75,000

Expenses 69,500
Net (Taxable) income 5,500
Tax payable: 5,500 x 48% 2,640

Non-residential Reinsurers:

Reinsurance premiums paid to non-residents are tax-free in their hands provided that the
insurance business in Papua New Guinea making the payments elects not to claim them as
deductions for tax purposes. If a deduction is claimed, premiums paid to non-resident
reinsurers will be taxed in the same way as normal insurance contracts. However, in the case
of reinsurance all premiums are taxable. In addition, any payouts from the reinsurers would
be assessable income.

Example

A resident insurance company receives a premium of K100,000 in return for providing K5

million insurance cover for a large trading corporation. It decides to reinsure half of this
amount with an overseas insurer. It pays a premium of K50,000.

If the resident insurance company does not claim the reinsurance premium of K50,000 as a
tax-deductible expense, it is not required to deduct any withholding tax from the payment.
However, if it did claim K50,000 as an expense, it must withhold 48% of K5,000 (taxable
income being 10% of K50,000), which is K2,400 and submit to the IRC.

As a resident is deemed to be the agent of the non-resident insurer, the resident normally
lodges an annual income tax return on behalf of the non-resident insurer/s. This means the
tax payable on non-resident insurance premiums is assessed on an annual basis and the tax is
collected under the provisional tax system applicable to companies.

Non-Resident Shipowners (Section190-196)

The taxable income of a non-resident shipowner or charterer which carries passengers or loads
freight from any Papua New Guinea port is deemed to be 5% of the gross fares or freight for
passengers or goods loaded at a Papua New Guinea port. The tax rate is the non-resident
company rate of 48%. The master of the ship and the agent are both liable for the tax.

Customs Officers should refuse to give clearance until satisfied that the tax has been paid.
The tax on fares or freight payments is effectively 2.4% (5% of 48%).

Example

Freight charged for goods loaded onto a foreign ship at Lae: K75, 000

Tax liability of the foreign ship owner or charterer will be:

Taxable income 75,000 x 5% = 3,750

Tax payable 3,750 x 48% = 1,800
Interest paid to Non-residents

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All interest paid to non-residents is subject to withholding tax of 15% (except for interest paid
by resource companies involved in resource operations to non-resident lenders in respect of
borrowing approved by the Bank of Papua New Guinea and interest paid by a licensed
financial institution in respect of a foreign currency deposit approved by the Bank of Papua
New Guinea). This is a first and final tax. But interest withholding tax is limited when paid
to individuals from certain countries with which Papua New Guinea have double tax
agreements (e.g. Australia).

Interest withholding tax

Section 187 of the Act provides where interest is paid or credited by a financial institution,
the Central Bank or a company to a person resident in Papua New Guinea, the person making
the payment of or crediting interest in the account is liable to withhold and pay tax upon that
amount at the rate of 15%. It also provides that where interest is paid or credited by any
person to a non-resident, the person making the payment or crediting the interest in the
account is liable to withhold and pay tax upon that income at 15%. This rate of withholding
tax may be reduced to 10% under an applicable Double Tax Agreement. Where interest is
paid or credited to a non-resident and has been subject to IWT this is a final tax in PNG.

Section 187 (A) specifically states that the IWT provision will not apply where:

(a) where interest paid is exempt under provisions of this Act; or

(b) where interest is received by a financial institution, Central Bank or the State.

To this end a financial institution is defined to mean “the Bank of Papua New Guinea and a
bank or financial institution licenced under the Banks and Financial Institutions Act, 2000”.

With reference to the exclusion provided by Section 187(4)(a), interest income may be
specifically exempt from tax in PNG or may be exempted by virtue of it being derived by an
entity exempted from tax in PNG.

Section 35(2)(c) of the Act provides the following interest payments are exempt from tax in
PNG:

“interest income derived by any person from a foreign currency deposit where-

(i) The Bank of Papua New Guinea has given its authority under the Central Banking
(foreign Exchange and Gold) Regulation (Chapter 138) for the placing of that
deposit in a foreign currency with a financial institution appointed as an
authorised dealer under Section 2(I) of that Regulation;”

Section 35(2)(e) of the Act provides the following interest payments are exempted from tax
in PNG:

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 “interest derived by a non-resident lender from a company engaged in mining,
petroleum or gas operations in Papua New Guinea, to the extent such interest is
payable under a financial arrangement approved by the Bank of Papua New
Guinea”

Section 187 of the Act only imposes withholding tax where there is a payment of interest.
Consequently, if the financing arrangement were structured in such a way that the return to
the borrower was not interest at general law, interest withholding tax would not be payable.
Based upon our understanding of Australian case law discounts on financial instruments such
as bills of exchange or promissory notes are not interest but a deductible on an accrual basis
over the life of the instrument. Where such discounts are sourced in PNG the discount less
any expenses applicable to deriving the discount would be subject to tax in PNG at the rate of
48% unless the non-resident holder of the instrument was protected from tax in PNG under a
double taxation agreement. The IRC may attempt to resist the adoption of Australian case
law in PNG and this may result in a future dispute.

Dividends paid to Non-residents.

Non-residents (whether individuals or companies) in receipt of Papua New Guinea dividend

income have dividend (withholding) tax of 15% deducted as a first and final tax, unless a
different rate is specified in a double tax treaty.

Dividend Withholding Tax

Dividends paid out of non-resource income are subject to dividend withholding tax at the rate
of 15% unless this is limited by a double tax agreement (typically to 15%), or the company is
a mining company in which case the rate is limited to 10%. There is no dividend withholding
tax on dividends paid out of petroleum or gas income.

Interestingly, the dividend withholding tax imposed on profits paid out of mining income is
apparently determined with reference to whether or not the company is carrying on mining
operations as opposed to being determined with reference to the source of the profits (i.e.,
sourced from mining income or non-mining income).

Dividends paid directly or indirectly out of income that was assessable income from petroleum
or gas operations is not included in the assessable income of shareholders. Dividends
withholding tax is not imposed on exempt income and it is for this reason that dividends paid
out of petroleum or gas income are not subject to dividend withholding tax.

Lease Payments to Non-resident Associates (Section 68AE)

Lease payments to a non-resident associate person or company for the lease of equipment may
not be fully deductible. The deduction is limited to an amount equivalent to the depreciation
on a diminishing value basis, or at the option of the taxpayer, prime cost method, and an
amount for interest on a loan at commercial rates had the resident taxpayer purchased that
asset. Such lease payments will of course in most cases remain subject to foreign contractors’
tax.

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Example

ABC (PNG) pays K35, 000 to its parent, ABC (AUST), for the lease of equipment which is
new and costs K1 million. Normal depreciation for such equipment is 10% prime cost, or
15% diminishing value method. Commercial loans available for the purchase of business
equipment at this time carried an interest rate of 12% per annum.

The amount of the lease payment of K35, 000 allowable for tax purposes would be calculated
as follows:

Depreciation (diminishing value method) 100,000 x 15% 15,000

Notional interest payable 100,000 x 12% 12,000
27,000

In this case, 27,000, not 35,000 would be an allowable deduction.

Transfer Pricing

Transfer pricing refers to the charges for goods, services, products and use of intangible
property between related parties. Many tax jurisdictions provide guidelines to taxpayers on
how to set a transfer price to ensure that the price is set on an arm’s length basis.

“Transfer prices are significant for both taxpayers and tax administrations because
they determine in large part the income and expenses, and therefore taxable profits, of
associated enterprises in different tax jurisdictions.” [OECD Transfer Pricing
Guidelines – Preface.]

Transfer pricing guidelines are generally an anti-avoidance measure which prevent global
taxpayers taking advantage of difference tax rates and other factors, such as availability of tax
losses, to minimize their global tax costs by setting international related party charges in such
a way as to minimize tax. For example, if a multi-national organisation sells goods to a
subsidiary in a different country at an inflated price, the profits in that country and related tax
cost will be lower. Most tax systems that apply legislation relating to transfer pricing allow
taxpayers to set a transfer price but have systems in place to make adjustments to that transfer
price where it is deemed to be outside an arm’s length range.

With the growing economy in PNG, there is an increased level of international investment
and activity. To protect the PNG tax base the IRC believe it is now essential for the transfer
pricing provisions of Division 5 of the Income Tax Act to be actively administered to counter
all forms of international profit shifting.

The provisions that deal with transfer pricing in international transactions are contained in
Division 15 (Sections 197A – 197G). In broad terms these provisions enable the IRC to
impose an arm’s length price on international transactions. Where goods or services are
acquired from related parties the price at which the goods or services are acquired is the
transfer price. Where the transfer price exceeds the price at which the same goods or services
could be acquired from a third party, charging a price above the arm’s length amount results
in profits being transferred from one country to another. In some cases, this will mean that
either no tax or a lower amount of tax is paid on those profits in PNG.

When the IRC is not satisfied that a taxpayer is dealing with a non-resident party on an ‘arms-
length basis’, the Act empowers the IRC to adjust the taxpayer’s taxable income to an amount

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it estimates would have been derived had the taxpayer been dealing on an arm’s length basis
with the non-resident party.

Section 197 provides for a limitation on deductions allowable for the price of goods purchased
from a foreign (or Papua New Guinean) company that is not on an arm’s length basis. The
IRC may adjust the purchase price of all trading stock where the buyer and seller are not
dealing at arm’s length and the IRC considers the transfer price excessive.

Taxation Circular No 2 of 2011

Taxation Circular No 2 of 2011 (“the Circular”) provides guidance on the operation of

Division 15. The Circular is a guide to current practice of the IRC – it therefore applies to
years commencing both before and after its date of issue.

There are a number of ways to determine an arm’s length price. However, the arm’s length
principle generally requires a comparison of the taxpayer’s position to that which would be
expected to be adopted by independent entities carrying out the same or similar transactions,
i.e. the “controlled” transaction under review and the “uncontrolled” transactions are
comparable. To be comparable the transactions compared should not be materially different,
or it should be possible to make adjustments to eliminate any differences.

The extent that transactions are comparable will be affected by the amount of data available
to make the comparison. The Circular notes that comparability will also be affected by:

• the characteristics of the relevant goods and services.

• the relative importance of functions performed.
• the terms and conditions of relevant agreements.
• economic and market conditions; and
• business strategies.

For example, for tangible property the value of the goods will be affected by such things as
quality, reliability and volume of supply, whereas the value paid for services will be affected
by the nature and extent of the services provided. For intangible property the anticipated
benefits from the use of the intangible property plus the length of time that the intangibles are
available will be some of the determining factors affecting price. The amount paid to an entity
for provision of tangible property, services or intangibles will also be determined by the
functions an entity carries out and the amount of risk assumed by that entity. These functions
should be compared when a “controlled” transaction is compared to the transaction, the higher
the compensation should be for the tasks performed or goods provided.

It is recommended that a “functional analysis” is carried out to determine which functions are
undertaken by each entity involved in a transaction and for which they should be rewarded.
This is also used to benchmark the transactions of the company under review to the
independent entity against which they are comparing their prices. A functional analysis is
used as a tool in assisting the selection of a transfer pricing method and in determining an
arm’s length price. Some other points to consider are:

• the contractual terms of the arrangements – independent parties will seek to hold each
other to the terms of the contract whereas associates may not.

• economic circumstances – these may vary across markets due to geographic location,
size, extent of competition, availability of substitute goods and services, transport costs

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 and whether the market is wholesale or retail; business strategies – this may legitimately
influence price, for example prices may be lower in a market penetration strategy.

The OECD and the Circular outline a number of acceptable methods for determining an arm’s
length price, these are:

• the comparable Uncontrolled Price – the “CUP” Method

• the Resale Price Method
• the Cost-Plus Method
• the Transactional Net Margin Method (“TNMM”)
• the Transactional Profit Split Method

The CUP, Resale Price and Cost-Plus methods are referred to as the traditional methods,
whereas the TNMM and Transactional Profit Split methods are referred to as transactional
profit methods as acceptable transfer pricing methods, the most appropriate of which will
depend on the particular situation and what data is available to ensure its proper application.

Example

The following examples are designed to give the reader an understanding of how transfer
pricing regulations may apply to prevent taxpayers from inappropriately shifting profits out
of PNG.

1. ABC (PNG) Ltd purchased merchandise from ABC (Australia), an associated company,
for K800, 000. It submitted the following figures in its income tax return for the year
of income.

Sales income 1,000,000

Cost of goods sold 800,000
Allowable expenses 195,000 995,000
Taxable income 5,000
Company tax payable @ 30% 1,500

The IRC ruled that the merchandise purchased in Australia could have been purchased
at normal wholesale prices, for K500,000.

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 The taxable income for ABC (PNG) was revised as follows:

Sales income 1,000,000

Cost of goods sold 500,000
Allowable expenses 195,000 695,000
Taxable income 305,000
Company tax payable @ 30% 91,500

2. A logging company exported timber to Korea for a total sum of K6 million. It submitted
the following figures to the IRC for the year of income:

Sales income from export of logs 6,000,000

Operating expenses 7,000,000
Net loss (to be carried forward) 1,000,000

The IRC adjusted the company’s trading income by revaluing the timber exported
according to then prevailing world market prices.

The company’s figures were revised as follows:

Sales income from export of logs 13,000,000

Operating expenses 7,000,000
Taxable income 6,000,000
Company Tax payable @ 30% 1,800,000

Double Tax Agreements

Papua New Guinea has currently double tax agreements with the following countries

Australia Canada China

Malaysia Singapore United Kingdom
Fiji South Korea Germany
Indonesia New Zealand Thailand (not yet ratified)

Treaties with other countries are at various stages of negotiation.

The Need for Double Tax Agreements

The chief reason for double tax treaties is to avoid income being taxed twice where the source
of income is different from where the recipient of income is resident. They establish which
country has taxing rights in cases where a resident of one country earns income from another
country. Papua New Guinea has a ‘global’ system of taxation, which means it taxes its
residents on their global income. Other countries, such as Hong Kong, have a ‘territorial’
system which taxes all income arising in its country. Thus, a Papua New Guinea resident with
a Hong Kong source of income will suffer taxation in both countries unless some tax relief
measures are available.

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Another example of double taxation is ‘economic double taxation’. This arises when the same
income effectively suffers tax in two locations but in the hands of different taxpayers. For
example, if a US company has a subsidiary in Papua New Guinea, the subsidiary will pay
Papua New Guinea tax on its profits. If these profits are remitted to the US parent, they will
be taxed again in the hands of the recipient company as dividends.

Other reasons for the introduction of double tax treaties are:

• to prevent or limit tax evasion and reduce the opportunities for transfer pricing and other
devices to avoid or limit the payment of tax. There is a developing trend in many
countries to regard international tax treaties as an additional means of policing in this
area. The tax treaties which Papua New Guinea have entered into are expressly for ‘the
avoidance of double taxation and the prevention of fiscal evasion…’ There are
provisions, for example, for exchange of information between different tax jurisdictions
to assist in the assessment of corporations and individuals.

• to ensure that tax rights (i.e. tax revenue) are shared out between countries on an
equitable basis.

• to encourage international trade and investment by reducing the possibilities of double

taxation and providing certainty as to the tax regime faced by investors and traders.

It is important to remember that although double tax agreements form part of PNG income
tax law they do not themselves impose taxation. When looking at whether income is taxable
in PNG it should first be determined whether the income is subject to tax under the domestic
law. Once it is determined that the income is taxable in PNG then you review the relevant
double tax agreement to determine whether the double tax agreement limits PNG’s right to
tax the income. For example, an Australian company providing consultancy services in PNG
for 20 days in a calendar year would be liable to foreign contractor’s withholding tax under
the domestic law. However, as the company does not have a “permanent establishment” in
PNG the PNG/Australia double tax treaty will operate to prevent PNG imposes tax on the
income.

The OECD Model Convention

An OECD Model Treaty was developed with the view of achieving harmonisation of the
bilateral treaties within member countries of the OECD, and thereby help eliminate double
taxation. Although most tax treaties follow the OECD Model there are some differences
which are largely geared to the economic development of the country.

Papua New Guinea International Double Tax Agreements

Payment of Dividends: Dividends paid by a resident company in one country (a) to a resident
in another country (b) will be taxed by the other country (b). However, such dividends may
be taxed by the country (a) in which the paying company is a resident, but should not exceed:

• Australia and Papua New Guinea -

15% of the gross dividend if that country (a) is Canada

25% of the gross dividend if that country (a) is Papua New Guinea.

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 (in practice 15% is withheld in line with the Rates Act)

• China and Papua New Guinea -

15% of the gross dividend if that country (a) is Australia

20% of the gross dividend if that country (a) is Papua New Guinea
(in practice 15% is withheld in line with the Rates Act)

• Canada and Papua New Guinea -

15% of the gross dividend if that country (a) is Canada

25% of the gross dividend if that country (a) is Papua New Guinea
(In practice 15% is withheld in line with the Rates Act)

• China and Papua New Guinea -

Normal tax payable on dividends if that country (a) is Papua New Guinea (15%). But
if the Chinese recipient of the dividends is the beneficial owner of the company issuing
the shares, the tax should not exceed 15% of the gross dividends.

• Malaysia and Papua New Guinea -

Normal tax payable on dividends if that country (a) is Papua New Guinea (15%). But if
the Malaysian recipient of the dividends is the beneficial owner of the company issuing
the dividends, the tax should not exceed 15% of the gross dividends.

• Singapore and Papua New Guinea -

15% of the gross dividend if that country (a) is either Singapore or Papua New Guinea.

• United Kingdom and Papua New Guinea -

15% of the gross dividend if that country (a) is either United Kingdom or Papua New
Guinea.

Interest and Royalties

Papua New Guinea and countries it has tax treaties with have agreed to the following rules
regarding the taxation of interest and royalties:

• interest or royalties paid by residents in one country (a) to residents in another country
(b) will be taxed by that other country (b).

• they may also be taxed in the country (a) where the interest or royalty arose but shall not
exceed 10% of the gross amount. These provisions override the provisions in the
Income Tax Act regarding withholding tax on interest (of 15%), and royalty payments
to non-residents outlined earlier in this unit.

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Salaries and Wages Payments between Non-residents

Salaries or wages (as well as gratuities and termination payments) to non-residents (e.g.
Australians) are taxable in the country where the employment takes place (e.g. Papua New
Guinea). However, income would be taxable only in the recipient’s country if payment is
made by a non-resident, the salary and wages are not claimed as an income tax deduction by
a business in PNG and the duration of employment is no more than a total of 90 days or six
months during the year – depending on the particular Tax Agreement. In the case of Australia
and Canada the duration of employment is 90 days. With other countries with whom there is
a tax agreement the duration of employment is six months.

Payments for Independent Professional Services

A non-resident (e.g. Australian) who earns income for performing independent professional
services in another country (e.g. Papua New Guinea) will be taxed only in his own country of
residence providing:

• he has not operated from a fixed base established in the country where the income is
earned.
• his stay in the country does not exceed the limit stated in the particular tax agreement:

➢ 90 days during the calendar year – agreement with Australia, Canada and
Singapore
➢ 6 months during the calendar year – agreement with Malaysia and Germany
➢ 6 months during any 365 days period – agreement with China, Korea and United
Kingdom
➢ 120 days during any 365 days period – agreement with Fiji

• the income earned during the period specified in the agreement does not exceed the limit
stated in the particular tax agreement:

➢ US$5,000 or its kina equivalent – agreement with Canada, China and Malaysia
➢ A$8,000 or its kina equivalent – agreement with Australia
➢ K15,000 – agreement with Singapore
➢ No income limit – agreement with United Kingdom

‘Professional Services’ include services performed in the exercise of independent scientific,

literary, artistic, educational or teaching activities. It also includes the work of physicians,
lawyers, engineers, architects, dentists and accountants.

Under the tax agreement with United Kingdom, independent persons under contract can work
here for up to six months and earn an unlimited amount not subject to Papua New Guinea tax,
provided they are not employed from a fixed base established for the purpose of performing
the individual’s activities.

It should be noted that the provisions of double tax agreements take precedence over domestic
legislation where there is a conflict in provisions.

Aid Projects
Individuals and companies who are directly involved in aid projects are not subject to personal
or company tax. For a project to be considered an aid project, it must first obtain designated
aid status from the Department of Foreign Affairs.

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Self-Assessment Exercises

Question 1

A taxpayer’s total taxable income for the year ended 31 December 2013 was as follows:

Salary 67,500
Rental income from Fiji 140,000
Interest income from New Zealand 20,500
Dividend income from UK 10,400

Foreign tax paid in respect of the taxpayer’s overseas income was:

Rental income 45%

Interest income 15%
Dividend income 25%

Calculate net tax payable by the taxpayer on non-salary income.

Question 2

A sole trader with three dependants during the year of income ended 31 December 2013
earned the following taxable income:

Papua New Guinea trading income 7000,000

Overseas income (New Zealand) 100,000 (NZ tax paid -45,000)
Overseas income (Australia) 50,000 (Aust. Tax paid – 5,000)

Calculate Papua New Guinea tax payable

Question 3

A taxpayer had the following income for the year ended 31 December 2013:

Salary 58,000
Interest from Westpac, Lae (net of 15% tax) 12,070
Interest from Westpac in Brisbane (net of 10% tax) 10,800
Share of partnership income 525,000

Calculate net tax payable on non-salary income.

Question 4

A taxpayer had the following taxable income for the year ended 31 December 2013:

Salary 60,000
Overseas interest (net of tax – 10% deducted) 22,698
Papua New Guinea dividends (net DWT) 21,165
Partnership income 120,000

Calculate net Papua New Guinea tax payable on non-salary income

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Question 5

A Papua New Guinea company with overseas operations had the following income figures:

PNG Income Overseas Income

Year 1 10m Fiji income 1.5m (loss)
Aust. Income 1m
Year 2 12m Fiji income 2.7m (loss)
Aust. Income 1.8m (loss)
Year 3 8m Fiji income 3.4m
Aust. Income 2.3m

Calculate net tax payable in each year.

Question 6

A Papua New Guinea company awarded a contract to a foreign (non-resident) construction

company. The gross income of the foreign company in one particular year of income from
the project amounted to K65 million. Its worldwide gross income was 750m and its
worldwide administration and managerial expenses amounted to K37.5 million.

A. Calculate PNG taxable income, and tax payable in respect of the gross contract income
of 65m

B. If the Papua New Guinea company did not withhold any tax from the foreign company,
explain what the consequences would be.

C. Assume the company submitted a tax return. It claimed K4 million for administration
expenses in connection with the contract incurred in its overseas head office. Comment
on the deductibility of this expense.

Question 7

Nippon (PNG) Limited sells trucks in Papua New Guinea and is a PNG incorporated
subsidiary of Nippon (Japan), an international company which manufactures various types of
vehicles.

Figures for Nippon (PNG) for one year of income were as follows:

Sales K12m
Allowable deductions (excluding management fees) 8.5m
Management fees Nippon (Japan) .5m

A. Calculate the allowable deduction for management fees paid to the parent company.

B. What withholding tax in respect of management fees paid would be payable?

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Question 8

A Papua New Guinea subsidiary of a New Zealand company pays royalty fees of 1.75 million
to its New Zealand parent for architectural designs developed in the company’s head office.

A. What taxes would normally be withheld from this payment?

B. If the foreign company was a non-associated company, what taxes would be normally
withheld by the Papua New Guinea company?

C. If the New Zealand company, being a non-associated company, incurred the following
expenses in relation to the design work:

Payment to agency in NZ for hire of architects for additional

Design work 725,000
Travel and accommodation expenses in PNG in connection
with this work 122,500

Calculate taxable income and tax payable.

Question 9

A Papua New Guinea shipping company took out marine insurance with a foreign insurance
company, paying a total premium of 130,000.

A. How much of this premium would be withheld and paid to the IRC?

B. If the shipping company did not withhold any tax, what would be the tax implications
for the shipping company?

Question 10

A company was declared by the IRC to be ‘profit shifting’ by under invoicing exports sold to
an overseas associated company. The IRC revalued upwards goods for 8.2 million by 70%.
Operating expenses of the company were 5.7 million.

Calculate the extra tax payable as a result of the IRC’s ruling.

Question 11

A Papua New Guinea company issued the following trading results:

Gross sales 7m
Cost of goods sold 5m
Allowable operating expenses 1m

The IRC deemed the goods imported for sale were not purchased on an ‘arm’s length’ basis.
It ruled that goods purchased from an associated company for 1.5m had a normal wholesale
price of .9m.

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Calculate: a. revised profit figure.
b. extra tax payable by the company as a result.

Question 12

A Papua New Guinean resident company distributed gross dividends of 100,000 each to
shareholders resident in Canada, Australia, United Kingdom, China, Malaysia and Singapore.

Calculate the maximum Papua New Guinea tax on dividends permitted in each case under the
bilateral tax agreements.

Question 13

An Australian educational consultant from Melbourne was employed in 2013 by a Papua New
Guinea university to improve the quality of courses on offer in its Commerce Department.
The consultant was paid K30,000 for spending a one-month period in the country.

Calculate how this sum would be taxed in Papua New Guinea if the consultant was paid by
(a) the Papua New Guinea university (b) an Australian university (c) AusAID as part of
Australian aid to PNG.

Question 14

A manufacturing proprietary company had a net profit of 2,000,000 (before tax) in the year
of income 2000. To assist you arrive at the taxable income figure, you are given the following
information:

• Interest of K54,000 (net) received from Singapore (10% foreign tax paid).

• Dividend income of K119,000 (net) received from Australia (15% DWT paid).

• Second-hand Grader was purchased for 300,000 at start of year. Depreciation of 20%
was claimed – prime cost method.

• Repair expenses of K120,000 consisting of:

➢ K30,000 repainting premises.

➢ K40,000 repairing computers which included K20,000 to upgrade memory; and

➢ K50,000 repairs to grader (see above) which was out of order when purchased.

• Education expenses of K16, 000: fees of K4, 000 to private high school, and K12, 000
for university fees.

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• Provisions during the year were:

➢ K20,000 – creation of provision for doubtful debts; and

➢ K40,000 – increase in provision for furlough leave.

• A new machine costing K250, 000 used in the manufacturing process of the business
was purchased at the start of the year. It had an expected life of 8 years and estimated
residual value of K50, 000. Depreciation was claimed using prime cost method.

• The company paid the membership fees of three of its senior staff to the local golf club,
which cost a total of K2, 500.

Calculate taxable income and net tax payable.

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Answers to Self-Assessment Exercises

Question 1

Total taxable income 238,400

Gross tax payable (at 2013 resident tax rates) 86,570
Less gross tax on salary income 18,335
Tax on non-salary income 68,235

Average rate of Papua New Guinea tax payable:

86,570
x 100% = 36.31%
238,400

Papua New Guinea tax payable in Fiji income: 140,000 x 36.31% = 50,834.00

Fiji tax on rental income: 63,000 (credit limited to PNG tax payable of K50,834.00)

Papua New Guinea tax payable on NZ income: 20,500 x 36.31% = 7,443.55

NZ tax on interest income: 3,075 (full credit allowed for NZ tax paid)

Papua New guinea tax payable on UK income: 10,400 x 36.31% = 3,776.24

UK tax on dividend income : 2,600 (full credit allowed for UK tax payable)

Gross tax payable on non-salary income: 68,235

Less credit for tax payable on Fiji income 50,834
Less credit for NZ tax paid 3,075
Less credit for tax payable on UK income 2,600 56,509
Net Papua New Guinea tax payable 11,726

Question 2

Papua New Guinea trading income 700,000

Overseas income (New Zealand) 100,000 (NZ tax paid – 45,000)
Overseas income (Australia) 50,000 (Aust. Tax paid – 5,000)
Total income 850,000

Gross tax payable (at 2013 resident rates) 343,210

Less tax rebate for dependants 1,050
Total tax payable 342,160

Average rate of Papua New Guinea tax payable:

342,160
x 100 = 40.24%
850,000

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Papua New Guinea tax payable on NZ income
100,000 x 40.25% = 40,250 (ANZ tax paid is K45,000. (credit limited to PNG tax payable
of K40,250)

Papua New Guinea tax payable on Aust. Income

50,000 x 40.25% = 20,125 (credit allowed for Aust. Tax paid of K5, 000 being the lesser
amount)

Tax payable 342,160

Less credit for NZ tax paid 40,250
Less credit for Aust. Tax paid 5,000 45,250
Net Papua New Guinea tax payable 296,910

Question 3

Salary 58,000
Interest form Westpac, Lae – gross 14,200
Interest form Westpac, Brisbane – gross 12,000
Share of partnership income 525,000
609,200

Tax on total income (609,200) at 2013 resident rates 242,074

Less tax (gross) on salary income 15,010
Tax on non-salary income 227,064

Average rate of tax paid:

242,074
x 100 = 39.74%
609,200

Less: Credit for Aust. Tax paid on Aust. Income 12,000 x 10% = 1,200
Credit for PNG interest withholding tax 14,200 x 15% = 2,310 3,330
Net tax payable on non-salary income 223,734

Question 4

Salary 60,000
Overseas interest (gross) 25,220
Dividend income (gross)* exempt
Partnership income 120,000
Taxable income 205,220

Gross tax on total income (at 2013 resident rates) 73,298

Less gross tax on salary income 15,710
Tax on non-salary income 57,588

Average rate of tax paid:

73,298
x 100 = 35.72%
205,220

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Less: credit on dividend
(withholding) tax 25,500 x 17% (DWT is a final tax) 0
credit on overseas interest 25,220 x 10% = 2,522 2,522
Net tax payable on non-salary income 55,066

*All PNG dividend income derived by individuals from 1 January 2006 year is exempt
income.

Question 5

Year 1 Tax payable 10m x 30% = 3m

Overseas losses carried forward .5m
Year 2 Tax payable 12m x 30% = 3.6m
Overseas losses carried forward 4.5m
Year 3 Tax payable 8.7m x 30% = 2.61m
(Overseas income 5.7m less cumulative loss 5m - .7m)

Question 6

A. Taxable income would be deemed to be 65m x 25% - 16.25m

Tax payable would be 16.25 x 48% = 7.8m (12% of gross income – Foreign contractor
tax rate)

B. If the Papua New Guinea company did not withhold any tax and the foreign company
had not made other arrangements for the payment of tax with the IRC, the Papua New
Guinea company would be liable to pay a maximum fine equal to 7.8 million – the
amount of tax payable by the foreign company.

C. Maximum overseas administration expenses allowable: Lesser of: 5% of gross income:

3.25 million; or 8.6% (proportion of Paua New Guinea income to worldwide income)
of 37.5 million = 3.251 million. 4 million would not be allowed. Maximum allowed
would be 3.25 million.

Question 7

A. Tax deductibility of management fees to Nippon (Japan) Limited: Greater of: 2% of

assessable income of K12m = K240,000 or 2% of 8.5m (allowable deductions) =
K170,000. K500,000 would not be allowed. Maximum allowed would be K240,000

B. Withholding tax would apply to that portion of the management fees which were
deductible which is 17% of K240,000 = K40,800.

Question 8

A. 30% - 525,000

B. 10% - K175,000

C. Taxable Income: 175m – 847,500 = 902,500

902,500 x 48% = 433,200

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Question 9

A. 130,000 x 4.8% = 6,240.

B. If the insurer had not made alternative arrangements with the IRC, the shipping company
could not claim the premium of 130,000 as an allowable deduction.

Question 10

Tax payable on unadjusted figures : 2.5m x 30% = .75m

Tax payable on adjusted figures : 8.24m x 30% = 2.472m
Extra tax payable : 1.722m

Question 11

a. 1.6m
b. 600,000 x 30% = 180,000.

Question 12

Canada 25,000 (in practice the maximum would be 17% - 17,000 as this is
the maximum payable under the domestic law)

Australia 20,000 (in practice the maximum would be 17% - 17,000 as this is
the maximum payable under the domestic law)

United Kingdom 17,000

China 15,000 As the recipient is a resident of China and the beneficial

owner of the dividends

Malaysia 15,000 As the recipient is a resident of Malaysia and the beneficial

owner of the dividends

Singapore 15,000

Question 13

(a) The amount would be taxable (at the non-resident salary and wages tax rates) if paid by
a Papua New Guinea resident, since it exceeds A$8,000 and the definition of salary and
wages includes remuneration by way of fees or otherwise for professional services or
services as an adviser, consultant or manager.

(b) Non-taxable as paid by non-resident (the individual’s stay in PNG was less than 90 days
and they did not have a fixed base in PNG). In this case the sum would be subject to
Australian tax.

(c) The income would be non-taxable.

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Question 14

Net profit before tax 2000,000

Add: Non-deductible / Assessable items
Tax on Interest – Singapore 6,000
Tax on Dividend income – Australia 21,000
Computers – upgrading memory 20,000
Repairs to grader (initial expenses) 50,000
Provisions 60,000
Depreciation on machine purchased 25,000
Membership fees 2,500 184,500
2,184,500

Deductible / Non-Assessable items

Depreciation on repairs expense to grader 10,000
Cost of machine purchased 250,000 260,000
Taxable income 1,924,500
Tax at 30% 577,350
Less: dividend rebate (140,000 x 30%) 42,000
Foreign tax credit – Singapore income 6,000 48,000
Net tax payable 529,350

Notes:

• Singapore interest income must be grossed up to K60, 000. K54,000 is already included
in income. Therefore, need to increase income by the Singapore tax deducted of K6,000.

• Australian dividend income must be grossed up to K140, 000. K119, 000 is already
included in income. therefore, need to increase income by the Australian tax deducted
of K21,000.

• Expenses in repairing grader just purchased should be capitalised and depreciated on

total amount.

• Machine used in manufacturing process can be fully claimed for.

• Rebate for tax on dividend income since that income has already been taxed.

• Tax credit on Singapore income limited to lesser of foreign tax paid or PNG tax payable.
In this case a full credit can be claimed for the Singapore tax paid. No tax credit can be
claimed for Aust. Tax paid on the dividends as these are subject to dividend rebate so
no PNG tax payable on them.

• Education expenses included fees for tertiary education. These are deductible to the
company. However, if paid in respect of a child of an employee the benefit of the
payment may be subject to salary and wages tax in the hands of the employee.

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Self-Assessment Test

Question 1

Income earned by a Papua New Guinea non-resident is:

a) not taxable if that income is derived in Papua New Guinea

b) not taxable if that income is derived overseas

c) fully taxable regardless of the source of income

d) taxable if the income was derived overseas

Question 2

Income derived from an overseas source by a Papua New Guinea resident is:

a) tax free

b) taxed only in the country where the income is derived

c) taxed at normal personal income tax rates

Question 3

A company driving overseas income:

a) is entitle to a rebate equal to the tax payable if the income is dividends

b) is entitle to a credit equal to overseas tax paid

c) will be subject to the terms of a double tax agreement

d) is entitled to a credit equal to the amount of Papua New Guinea tax payable

Question 4

Losses incurred in deriving overseas income:

a) may be carried forward indefinitely and offset against taxable income

b) are an allowable deduction against a taxpayer’s income

c) are an allowable deduction against a taxpayer’s overseas income

d) are not deductible against income

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Question 5

Foreign contractors’ tax is:

a) levied at 48% of (a notionally calculated) taxable income

b) a withholding tax that is a first and final tax

c) levied at 12% of gross income

d) all of the above

Question 6

Management fees:

a) paid to related companies are not deductible

b) are subject to 17% with-holding tax

c) are an allowable deduction

d) paid to related companies may not be fully deductible

Question 7

The main purpose of double tax agreements is to:

a) minimise tax evasion

b) avoid taxpayers being taxed twice on the same income

c) promote trade and investment between countries

d) all of the above

Question 8

Interest paid by a Papua New Guinea company to an Australian resident will be subject to:

a) tax at normal personal income tax rates

b) withholding tax of 10%
c) withholding tax of 15%
d) withholding tax of 17%

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Question 9

In the double tax agreement between Papua New Guinea and Australia, if a clause in the
agreement conflicts with the tax law of either country:

a) the provisions of Papua New Guinea income tax legislation will prevail

b) the provisions of Australian income tax legislation will prevail

c) the provisions of the double tax agreement will prevail

d) each country will apply its own domestic tax legislation

Question 10

An overseas company which incorporates a local subsidiary:

a) will be subject to corporate company tax at normal Papua New Guinea rates

b) will pay a higher tax rate of 48%

c) will play a higher tax rate, but will not be subject to dividend withholding tax

d) may claim a full deduction for management fees paid to the parent company

Answers: Self-Assessment Test

Question 1

Non-residents are taxed in Papua New Guinea only on income derived in Papua New Guinea.
Therefore (b) is correct.

Question 2

(d) is the correct answer. (A credit is given if foreign tax has also been levied on the income.)

Question 3

(a) is correct – companies receive a rebate for tax payable on dividend income regardless of
their source. (b) and (d) are not strictly correct – a company deriving overseas income is
entitled to a credit equal to the lesser of overseas tax paid or Papua New Guinea tax payable.
(c) is correct in some cases, but not in all cases.

Question 4

Overseas’ losses may only be carried forward and offset against a taxpayer’s overseas’
income. (c) is therefore correct.

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Question 5

(d) is correct

Question 6

(d) is the correct answer. S.68AD limits the amount that may be claimed for management
fees if the companies concerned are connected. (b) is correct if the recipients are non-resident.

Question 7

(a) is the correct answer. The purpose of double tax agreements includes all possible answers
but avoiding double taxation is the main reason for such agreements.

Question 8

In accordance with the double tax agreement signed with Australia (and other countries),
withholding tax of 10% may be imposed on interest payments made to Australian residents.
(b) is therefore correct.

Question 9

(a) is correct. The provisions in the double tax agreement override the provisions in the
domestic income tax legislation.

Question 10

(a) is correct. (b) and (c) would apply if a branch rather than a subsidiary were established.
(d) is not correct because S.68AD may restrict the amount of management fees paid to an
affiliated company.

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9. TAXATION OF RESOURCE PROJECTS

Learning Objectives

After you have successfully completed the work in this unit you should be able to:

• Distinguish between mining, petroleum and gas projects.

• Understand how resource projects are taxed on a project basis.

• Explain what allowable exploration is and how it is amortised.

• Explain how exploration expenditure may be ‘pooled’ and transferred.

• Explain what allowable capital expenditure is and how it is amortised.

• Describe and apply the tax rates that apply to resource companies.

• Explain how Additional Profits Tax is calculated.

• Explain the following levies (where applicable): royalties, development levy and mining
levy.

• Describe how the infrastructure tax credit scheme operate.

• Explain how the State may participate in resource projects.

• Describe GST and stamp duties provisions relating to resource projects.

In recent years the tax provisions applying to mining and hydrocarbon (petroleum and gas)
projects have undergone major amendments. In the 2001 budget, recommendations of the
Bogan Tax Review were implemented. A separate review was conducted into the mining and
hydrocarbon sector. In the subsequent budgets, further amendments have been made. The
aim has been to make the tax regime more attractive to investors in order to arrest the decline
in exploration and production in this sector.

In this unit the licensing arrangements for the various types of resource projects are first
outlined. The tax regime, which applies to resource projects, is then considered.

Mining Projects

Mining operations means:

“the extraction of minerals in Papua New Guinea from their natural site and includes the
construction and operation of facilities.

Licence arraignments for mining are as follows:

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• Mining Lease (ML) provisions apply to small mining leases which are not of sufficient
scale to be subject to a special mining lease (e.g. the Tolukuma Mine and the Hidden
Valley Mine).

• Special Mining Lease (SML) provisions which are generally restricted to large scale
projects (e.g. the Porgera Mine and the Lihir Mine).

In addition, in the past very large-scale developments (e.g. Ok Tedi) may be governed by
special agreements negotiated with the government. Such agreements, however, do not vary
significantly from SML agreements.

Up until 2001 small mining operations subject to a Mining Lease were taxed under the general
tax provisions (e.g. subject to general company tax rates). However, now the basic taxation
of all resource projects which includes projects on Mining Leases and Special Mining Leases
is the same. Very small-scale operations under alluvial leases remain subject to general tax
provisions.

Special Mining Leases (SMLs)

Provisions of a Special Mining Lease (SML) through a mine development contract may alter
the taxation rules applicable to large-scale mining projects. As a general rule, any project
involving initial capital expenditure of over US$75 million is regarded as a large-scale project.
Such a project requires the mining company concerned to acquire a special mining lease.

Initially, when a mining operator wishes to explore for minerals, they must apply for an
Exploration Licence (EL). This should cover an area not more than 25,000 square kilometres.
The EL, usually for 6 years, and renewable, grants the holder exclusive rights to prospect for
specified minerals in that area. If a large-scale mineral deposit is discovered, the prospector
must then apply for a SML before mining operations can commence. The lease may cover an
area not more than 60 sq. kilometres.

Where the holder of an EL applies for a SML within that authority the exploration (and
development) expenditure in the area of the EL is transferred to the SML for taxation
purposes. A mining project may contain a number of SMLs and may also include one or more
ordinary Mining Leases (ML).

Petroleum Projects

A petroleum project includes an operation engaged in the recovery of petroleum and also
activities related to the transport of that petroleum to a terminal facility, such as a pipeline or
port. It also includes refining activities that are restricted to the recovery of oil. The definition
of petroleum operations in the Income Tax Act is:

“petroleum operations” means all or any of the of the following: -

(a) Operations in Papua New Guinea for the purposes of recovering petroleum, including the
construction or acquisition of facilities for that purposes.

(b) Operations for or related to the processing or transporting of petroleum prior to:

(i) Entry of the petroleum into a facility which is located in Papua New Guinea for the
refining of petroleum or liquefaction of natural gas; or
(ii) Export of the petroleum,

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 Whichever occurs first:

(c) The refining of petroleum or petroleum products where such refining is solely for the
purpose of or incidental to the operations in Papua New Guinea for recovering petroleum
or the construction of facilities used in those operations or where the Commissioner
General considers the refining is required in order for the taxpayer to be able to conduct
those operations;

(d) Exploration activities within the area of and pursuant to a development licence but does
not include exploration or gas operations.

Petroleum taxation provisions apply to all petroleum exploration and development in Papua
New Guinea, including the 200-mile offshore exclusive economic zone.

Initially, companies intending to engage in petroleum activities must apply for an exploration
licence, known as a petroleum prospecting licence (PPL), which covers a defined area,
maximum area usually 60 graticular blocks (though up to 200 blocks are allowed in special
circumstances), each approximately 9 square km). This requires submission and approval of
a detailed work and expenditure program for the licence area. The term of a PPL is 6 years,
plus one 5-year extension. A further extension of up to three years may be permitted in respect
of locations (e.g. declared discoveries). When petroleum has been discovered in commercial
quantities, a company may apply for a Petroleum Development Licence (PDL) and/or a
pipeline licence (PL). The accumulated exploration expenditure incurred may then be
“transferred” to the development licence and offset against income. PDLs are granted for 25
years, with one extension of 20 years possible.

An area that is the subject of a number of development licences and/or pipeline licences may
be treated as one project and ‘unitised’ for that purposes. For example, the SE Gobe oil field
is the subject of two petroleum licences, but it is unitised and treated as one project (along
with Gobe Main).

Gas Projects

In many respects a gas project is similar to a petroleum project. Initially when an exploration
licence (PPL) is issued, there is a no distinction made at that stage regarding whether gas or
oil is the main focus of exploration activity. A petroleum retention licence may be issued to
allow an investor more time (up to 15 years – 5 years plus two possible extensions of 5 years)
to find additional gas to enable commercial development to occur. A PDL is issued to enable
a gas project to be developed.

A ‘designated’ gas project may include one or more gas projects which are the subject of a
gas agreement between the State and the (other) parties involved in the project, in accordance
with the provisions laid down in the Oil and Gas Act. For example, the now abandoned PNG
Gas Project was the subject of a detailed gas agreement. In that case the gas agreement
contains specific rules which deal with the taxation of gas project companies when a
petroleum project converts to a gas project. These rules are also in the Income Tax Act.

A petroleum project may be converted to a designated gas project once the production of gas
exceeds a certain prescribed ratio of gas production to oil production, as laid down by
regulation. For example, if the PNG Gas Project proceeds, fields within the Kutubu Petroleum
Project will be converted to become part of a designated gas project. The significance of this

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is that fiscal terms applicable to a gas project (such as a lower tax rate and the terms of the
Gas Agreement) will then apply.

Project Basis of Assessment – Right Fencing (Section 156A)

Income earned from a resource project is assessed as if it were the only income of the taxpayer.
Deductions are restricted to expenditure connected with the project, except for limited
exceptions. Where there is deductible expenditure or income not relating exclusively to the
project (e.g. head-office expenses) then the expenditure or income is apportioned on a
‘reasonable’ basis. In this context one may say that the income and expenditure of a project
are ‘ring fenced’.

The main exception to the ring fence principle is in relation to additional ‘poled’ exploration
expenditure incurred in licences outside a particular project that may be claimed as a
deduction against income in another project. This shall be considered later.

Allowable Exploration Expenditure (AEE) (Section 155A – B)

Exploration expenditure includes the following:

• Expenses incurred in investigation the geology of a particular area, such as geological,

geophysical and geochemical surveys, and exploration drillings and appraisal drillings.

• Other expenses directly connected with such exploration. These might include
computer analysis of data, office and accommodation expenses for exploration staff.

Any income earned by the taxpayer during the period of exploration is deducted from
exploration expenditure in arriving at the amount of exploration expenditure available to be
carried forward. Such income may include interest, rent and the sale of petroleum from
extended well testing carried out in a petroleum exploration licence.

Interest incurred by the holder of an exploration licence is not an allowable deduction.

The amount of allowable exploration expenditure is determined at the time a development

licence is issued. This is exploration expenditure which was incurred within twenty years
before the date of issue of the development licence either in the area of the exploration licence
from which the development licence was drawn or on areas of an exploration licence which
has been surrendered, cancelled or expired. It may then be written off against income from
that development licence.

Deduction for Allowable Exploration Expenditure (Section 155C)

The deduction in any particular year for allowable exploration expenditure is the Undeducted
balance of exploration expenditure divided by 4 or the estimated remaining life of production,
whichever is less.

Note that, in the case of mining, the life of a project may continue sometime after actual
mining ceases, during which time ore may be taken from a stockpile and processed for gold
or other metals. This deduction cannot create a tax loss (i.e., it is limited to the amount of
taxable income remaining after deducting all other deductions other than allowable capital
expenditure).

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No deductions are allowed for exploration expenditure that occurred more than 20 years prior
to a development licence having been issued. This period was extended from 11 years.
However, the legislative amendments were not retrospective, i.e., exploration, which expired
under the old 11-year rule, cannot be reinstated (Section 155A (10)].

Transfer of Exploration Expenditure

Exploration expenditure incurred in the past on another exploration licence or development

licence that has been given up or surrendered within a time limit of 20 years may be transferred
to another active development licence in which the investor has an interest. However, this
only applies to petroleum exploration.

It is also possible for exploration expenditure incurred in an exploration licence to be

transferred (sold) to another investor. That investor may likewise transfer the exploration into
a development licence and amortise it against income. Again the 20-year time limit applies.
In this way unsuccessful exploration expenditure may still be utilised to benefit investors.

Pooling of Exploration Expenditure (Section 155N; Section156D & E)

Exploration expenditure incurred in exploration licences anywhere in the country may, from
1 January 2001 onwards, be accumulated in a common exploration pool, as provided under
Section 155N. Consequently, this pool is often referred to as the “155N Pool”. 25% of the
(reducing balance) value of this pool may be claimed as a deduction, in addition to normal
allowable expenditure deductions. The deduction may not create a tax loss and may not
reduce tax payable by the taxpayer on combined resource operations by more than (a) 10% in
the case of petroleum projects and (b) 25% in the case of mining projects (Section 156D).

Section 155N provides that a taxpayer must make an election to transfer exploration
expenditure to a Section 155N pool. This election must be made in writing, signed either by
or on behalf of the taxpayer and delivered to the Commissioner General no later than the due
date of the income tax return for that period (Section155N(2A)).

For mining and petroleum projects, where a development licence arises from an exploration
licence, any ‘pooled’ expenditure from that exploration licence may be withdrawn from the
pool and transferred to the development licence. The amount transferred should be the
undeducted balance, i.e. less any amounts already claimed as a deduction. However, for
mining projects, a double deduction is available for pooled expenditure if a successful
development arises. This applies to expenditure incurred on or after 1 January 2003. The
same exploration expenditure may be claimed as ‘pooled’ expenditure and as allowable
exploration expenditure in a development licence (Section 156E).

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Example

Assume a petroleum company and a mining company had the following taxable income
figures:

Petroleum Company Mining Company

Sales 1000 Sales 1000
Deductions 800 Deductions 800
Taxable income 200 Taxable income 200

Tax payable @ 30% 60 Tax payable @ 30% 60

Section155N deduction: Section155N deduction:

10% of tax payable 6 25% of tax payable 15
Therefore, Section155N deduction Therefore, Section155N deduction
(6/.30) 20 (15/.30) 50

Revised figures which incorporate Section 155N deduction

Petroleum Company Petroleum Company

Sales 1000 Sales 1000

Deductions 820 Deductions 850
Taxable income 180 Taxable income 150
Tax payable @ 30% 54 Tax payable @ 30% 45

In the above example, it is assumed that 25% of the (Undeducted) balance of the exploration
pool exceeds a figure that reduces tax by 10% and 25%, so the deduction is limited to the
lesser figures.

Let’s assume that details of the (Section 155N) exploration pool are as follows:

Exploration Exploration Section 155N Undeducted

Licence (EL) Expenditure (EE) Deductions Balance
101 500 100 400
102 600 120 480
103 500 130 370
Undeducted balance of pool 1250

Let’s now assume that a successful project emerges from EL 102 and a development licence
is issued. If it is a petroleum or gas project, the undeducted balance of exploration expenditure
– 480- may be transferred out to the new development licence. But if it is a mining project,
600 may be allocated to the development licence (assuming that all of the exploration
expenditure attributable to EL 102 was incurred after 1 January 2003). The remaining 480
may be claimed as Section 155N deductions in the future. In this way a double deduction is
available for mining exploration if it results in a successful development.

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Allowable Capital Expenditure (CE) (Section 155D)

There are also special provisions dealing with the income tax treatment of capital expenditure
incurred on the development of a resource project. This expenditure is called allowable capital
expenditure. In addition, the normal depreciation provisions of the Act may apply to
allowable capital expenditure with an effective life of less than 10 years.

Such development expenditure may include:

• provision of buildings and other improvements or plant.

• testing deposits or winning access to them.

• provision of water, light, power, for use on, or access to or communication with, the site
of mining operations.

• residential accommodation for the use of employees or their dependants, being

accommodation situated on or adjacent to the site of operations.

• health, educational, law and order, recreational or similar facilities and facilities for the
supply of conducted for profit-making purposes.

• feasibility and environmental impact studies.

• depreciable plant (but subject to an election to treat short-life assets as depreciable

plant).

• construction and operation of port or other facilities for ships or barges in connection
with the transport of minerals.

• general administration and management expenditure relating primarily and principally

to resource operations incurred after the date of issue of the relevant resource
development licence pursuant to which the resource project is conducted and prior to
the date on which the taxpayer first derives assessable income from resource operations.

• exploration expenditure which is incurred after the issue of a resource development

licence is to be treated as allowable capital expenditure rather than allowable exploration
expenditure.

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Deductions for Allowable Capital Expenditure (Section 155E)

Allowable capital expenditure (“ACE”) is amortised over the life of the resource project. The
allowable capital expenditure is split into two categories: capital expenditure with an
estimated effective life of more than 10 years (long-life ACE) and capital expenditure with an
estimated effective life of less than 10 years (short-life ACE). For short-life ACE the annual
deduction is calculated by dividing the unamortised balance by the lesser of the remaining life
of the project or four. This means the rate of write off while the project life is four or greater
is 25% using the reducing balance method. This is the same rate of write-off as applies to
allowable exploration expenditure.

Allowable capital expenditure on assets with a normal useful life of at least 10 years is written
off at a rate of 10% (straight line method). Such expenditure would include pipelines,
immovable field installations etc. However, for new mining projects, where the mining lease
or special mining lease was granted on or after 1 January 2003, all capital expenditure may be
amortised using 25% reducing balance method.

For both short life and long-life assets, a faster rate of write-off is allowed near the end of a
project’s life of production to permit all allowable expenditure to be written off within the life
of a project. To allow this, the amortisation divisor is the lesser of 4 or 10 (of the undeducted
balance in both cases), or the remaining number of years of production in each case.

Alternatively, the taxpayer can elect for assets resulting from short life allowable capital
expenditure to be depreciated under the normal tax depreciation rules which apply to plant
and equipment. Under these rules the assets would be subject to depreciation on either a
straight line or diminishing value basis at rates ranging from 5% to 20% under the straight-
line method and from 7.5% to 30% under the diminishing value basis. (Section 155F)

Section 155E (6) of the Income Tax Act limits the amount of the deduction which can be
claimed for ACE to the amount of income remaining after all other deductions. In other
words, ACE cannot create tax loss. Prior to 1 January 2008 there were no rules for
determining the order in which the deduction for long-life ACE and short-life ACE should be
claimed. The Act has been amended so that the order of the deduction is long-life ACE first
and if fully utilised a deduction for short-life ACE may be claimed. Where there is insufficient
income to use the deduction, the excess is deemed to be ACE incurred in the next year of
income.

Example (Mining Project Commencing Prior to 1 January 2003)

2012 year

2021 long-life ACE 1,000,000

Maximum ACE deduction (1,000,000)
9000,000

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If the taxable income remaining after deducting all deductions other than those for ACE for
the year is K50,000, the ACE deduction in 2012 is limited to K50,000. So the carrying balance
is as follows:

2012 long-life ACE 1,000,000

ACE deduction ( 50,000)
Closing balance 950,000

2013-year ACE

ACE incurred in 2013 250,000

ACE deemed incurred in 2013 50,000
TOTAL 2013 ACE 300,000

Maximum ACE deduction from 2013 ACE 30,000

Maximum ACE deduction from 2012 ACE 100,000

Environmental Protection and Clean-Up Costs – General Provisions

Expenditure incurred in relation to rehabilitating environment damaged by mining operations

often runs into significant numbers. The following provisions of the ITA operate to provide
specific deductions for environmental protection and clean-up costs:

Section 72D

Section 72D operates to provide a deduction for expenses incurred for the purposes of
‘environmental protection activities: This is an exhaustively defined term, and refers to the
prevention or clean-up of:

• pollution that has been caused (or is likely to be caused) by a taxpayer, or

• pollution that is present on a site that a taxpayer has or will be entitled to use.

This provision includes a number of specific exclusions, which are more in the nature of
integrity measures than substantive limitations. Specifically excluded is expenditure of a
capital nature that relates to the construction of a building, and expenditure that relates to the
acquisition of land.

Arguably the specific exclusions set out by Section 72D (3) are already excluded by the
wording of Section 72D (2) which refers to expenditure that is incurred for the ‘sole or
dominant purpose’ of environmental protection activities. The inclusion of a sole or dominant
purpose test should be carefully considered by a taxpayer embarking upon environmental
protection activities. It is important to ensure that this expenditure is separately documented
rather than being incorporated within the costs associated with a more comprehensive project.
For example, if a taxpayer wishes to construct a new building on a polluted site, it would be
advisable for that taxpayer to separately document ground preparation costs that relate to the
repatriation of the site rather than paying a single price for the project.

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Where a taxpayer had deducted an amount under Section 72D, the subsequent recoupment of
all or part of that expenditure is assessable income. In addition, where a site is subsequently
sold, the sale consideration will be deemed to be a recoupment of deductible environment
protection costs to the extent that a deduction has or could be claimed.

Section 72E

Section 72E permits an allowable deduction for the costs associated with preparing an
environmental impact study. These costs are deductible over the anticipated life of the project,
or ten years. Like Section 72D, this deduction is only available where costs are incurred for
the sole or dominant purpose of preparing an environmental impact study. Amounts that
represent a recoupment of prior expenditure are assessable.

Section 73

Plant or equipment used in the course of environmental protection activities or conducting an

environmental impact study is depreciable in accordance with Section 73 of the Income Tax
Act 1959.

Environmental Protection and Clean-Up Costs- Division 10

Sections 155T, 155U, 155V and 1155W in Division 10 of the ITA allow for resource
companies to claim deductions for environmental rehabilitation and clean-up costs incurred
at the end of a resource project. These provisions allow for losses resulting from these costs
to be transferred to new projects, subject to a cap.

Carry-Forward of Losses (Section 101 (4))

For taxpayers carrying on resource operations, losses can be carried forward indefinitely,
instead of being covered by the general 20-year limitation. However, losses may not be
transferred from one project to another. In addition, given the deductions for CE an AEE
cannot create a tax loss it seems unlikely new resource project will have tax losses.

Tax Rates for Resource Projects

Different tax rates apply for different types of resource projects. The rates are as follows:

Dividend Effective tax rate

Resident Non-
withholding on distributed
resident
tax rate income (resident)
Mining 30% 40% 10% 37%
Petroleum – existing projects 50% 50% 0% 50%
Petroleum – new projects 45% 45% 0% 45%
Petroleum–incentive rate projects 30% 30% 0% 30%
Gas 30% 30% 0% 30%

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The rates of income tax for a non-resident company which derives income from a petroleum
or gas project are the same as the rates for a resident company. The rates of income tax for a
non-resident company which derives income from a mining project is 40%. The rate of
income tax for existing petroleum projects is 50%. For new projects it is 45%. However,
from 2003 onwards, there is a new category, “incentive rate petroleum operations” on which
the tax is 30% of taxable income. An incentive rate petroleum project is one that commences
with an exploration licence issued or re-issued after 1 January 2003 and before 31 December
2007 and becomes operational under a development licence issued within the following 10
years as a flow on from the exploration licence. Companies whose planned exploration
program is acceptable to the Department of Petroleum and Energy will qualify for these
special incentive rate terms.

Payment of Tax (Section 311AM – AW)

Resource companies pay their income tax as they earn their income. This tax is called
Advance Payment Tax. Tax is paid in instalments, at the end of April, July and October.
Tax is initially based on estimates of taxable income for the year. These are prepared by the
taxpayer and reviewed by the Internal Revenue Commission. The tax instalments will
normally vary during the year as revised estimates for both income and deductions are
progressively replaced by actual figures in the estimates lodged by the taxpayer. In the
following year a tax return is submitted and assessed, and an additional payment or refund
will be made depending on the final assessment. This method of collection of income tax is
similar (but not identical) to the provisional tax system for other companies.

Petroleum companies (and most mining companies) submit their tax returns and pay tax in
US dollars. This is because their sales income and much of their expenditure is in US dollars.

Additional Profits Tax (APTD) (Section 159)

Additional Profits Tax APT) is a tax payable in addition to company income tax. The rationale
for this tax is to apply an additional tax on projects that are very profitable – which achieve
an above average rate of return. APT currently only applies to a taxpayer which has an interest
in a “designated gas project”. Therefore, APT is not levied on taxpayers involved in mining
or petroleum projects.

APT is triggered when a company has fully recovered its investment in a project and in
addition has exceeded a certain level of return on its investment. The starting point for the
calculation is a taxpayer’s initial investment in the project and this is referred to as “net cash
receipts”. When a company is still recovering its investment, its ‘net cash receipts’ will be
negative. This (negative) figure is uplifted or increased each year. Ultimately if net cash
receipts become positive, it means the company has recovered its investment in a project and
so APT becomes payable. The net cash receipts figure, when negative, is uplifted annually to
allow for a company to obtain a return on its investment as well.

The APT regime is a two-tier system. This enables APT at a certain rate to be charged when
a company achieves a certain rate of return; and APT is charged at a higher rate when a higher
level of return has been achieved. The example that follows should make this clear.

Net cash receipts measure the actual cash flow of a company in a project each year.

Net cash receipts are calculated as follows:

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 Sales income

less Expenditure on project capital

Operating costs
Overhead costs
Income tax paid

Note that income tax paid is included as this also affects annual cash flow. Excluded are ACE
and AEE deductions, since these are not cash outgoings. Also excluded are interest payments
and receipts.

In the early years of a project, the net cash receipts figure will accumulate at a negative rate.
The accumulated amount will be uplifted by the accumulation rate. Once sales income
commences, you would expect the annual net cash receipts figure to be positive. This will
have the effect of gradually reducing the negative accumulated net cash receipts figure.
Eventually the accumulated negative figure may be eliminated, i.e., become positive. It is at
this point that APT become payable. But only projects with an outstanding rate of return can
be expected to achieve this result.

Interest Deduction (Section 155H)

During the exploration phase, interest incurred is not an allowable deduction. Interest is
allowable during the development and production phase of a resource project, i.e., once a
development licence has been issued. However, the amount of interest allowable is restricted
by the application of a debt to equity ratio of 3:1. These thin capitalisation provisions have
been considered in module 4.

There is a further requirement in relation to foreign loans. Interest will only be deductible in
relation to a loan from a person who, in the opinion of the Commissioner General, is at arm’s
length if the taxpayer has notified the Bank of Papua New Guinea of the terms of the
borrowing, including the interest rate and other fees and charges related to the borrowing, and
the Bank of Papua New Guinea has given its authority for the borrowing under the relevant
Foreign Exchange Regulations.

Interest Payments [Section 35(2)(e)]

Resource companies operating in Papua New Guinea, when making interest payments to non-
resident financial institutions or companies, do not have to deduct interest withholding tax of
15%. This is because interest paid by a resource project company on approved foreign
currency debt is exempt from income tax and interest withholding tax. This exemption applies
even if the loan is from a related party.

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Management Fees (Section 155M)

For resource companies operating in a developing or exploration licence, the deduction

allowable management fees paid to associate companies is restricted to an amount which does
not exceed 2% of operating costs. During the exploration phase of a project the amount of
management fees which can be treated as allowable exploration expenditure is limited to 2%
of exploration expenditure other than management fees. Furthermore, during the
development phase the amount of management fees which can be treated as allowable capital
expenditure is limited to 2% of allowable capital expenditure other than management fees.
However, fees paid to associated companies to reimburse for expenditure directly related to a
resource company’s activities are allowable in the normal way.

The 2% limit should not apply to fees paid to a resident of a country with which PNG has a
double tax agreement where it is established to the satisfaction of the Commissioner General
of Internal Revenue that the amount charged has been determined on an arm’s length basis.
In January 2006 the Commissioner General issued a practice statement (PS 2005/1) which
provides taxpayers with guidelines on what is required to demonstrate the charge for
management fees has been determined on an arm’s length basis.

Development Levy (Section 161)

Following the introduction of the Oil and Gas Act of 1998, development levies were
introduced and will apply to future oil and gas projects. They are payable to the provincial
government in which a project is located. They are an allowable deduction and are calculated
at the rate of 2% of the wellhead value of oil or gas. The wellhead value is defined as being
the sale price less any costs incurred for transport and processing.

Royalties (Section 161)

At the present time royalties are payable by all licensees of resource projects. They are then
passed on to landowners and in some cases, provincial governments. They are an allowable
deduction. In the case of oil and gas they are calculated as 2% of the wellhead value of oil or
gas. For mining projects, they are calculated as 2% of sales value of mining products. Where
oil and gas projects are subject to both the development levy and royalties, the amount paid
as royalties is treated as a credit against the taxpayer’s income tax liability. Royalties paid by
a resource developer (whether mining, petroleum, fishing or timber company) are subject to
a withholding tax of 5% of gross royalties, unless the recipient landowners are duly registered
for tax purposes. A person paying such royalty must register as a paying authority and is
required to deduct and remit the tax withheld to the IRC.

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Infrastructure Tax Credit Scheme (Section 219C)

This scheme is aimed at encouraging operators in resource projects (along with taxpayers
engaged in primary production and large-scale tourism accommodation operations) to spend
money on infrastructure in the area in which the resource project is located (or other areas).
Approved projects generally take the form of public welfare type projects such as schools, aid
posts, hospitals, roads or other capital assets. From 2001 onwards, maintenance expenditure
on such infrastructure also comes under the scheme. Money spent on such projects is treated
as a tax credit – tax payable is reduced by the expenditure incurred on such projects – so there
is no cost to the company actually spending the money. An income tax deduction is not
available to the extent the expenditures deemed to be tax paid.

From 2001 onwards, the annual amount, which may be spent, on such projects is 0.75% of
assessable income (reduced from 2%). Any unutilised credits may only be carried forward
for a period of two years. In other words, if less than .75% of assessable income is spent in
one year, the remaining unused amount may be used up in the following two years, in addition
to the normal amount allowed. If a company overspends in one year, the extra amount spent
may be rolled forward but only for two years.

In the 2005 budget, section 219C was redrafted and expanded to include a 1% (of assessable
income) tax credit for taxpayers engaged in primary production. In the 2006 Budget and the
credit available was increased from 1% to 1.5% of assessable income. The provisions for
primary producers operate in the same manner as for taxpayers in resource projects.

Section 219C was further amended during the 2007 budget and has now been expanded to
include 1.5% (of the assessable income) tax credit for taxpayers engaged in tourism. The
provisions for taxpayers in the tourism industry operate in the same manner as for taxpayers
in the above two industries.

Highlands Highway Infrastructure Tax Credit Scheme

The special Highlands Highway infrastructure tax credit scheme of up to 1.25% of assessable
income was reinstated in 2012 to the extent the expenditure on the Highlands Highway is an
emergency repair.

An emergency repair means “an activity carried out to restore traffic flow following an event
that has resulted in the closure or partial closure of the highway, including bypass or
replacement of a section of the highway, replacing of culverts, construction of temporary
bridges and removal and repair of major landslips”.

State Participation in Resource Projects

The State is entitled to obtain a 22.5% interest in oil and gas (upstream) projects and a 30%
interest in mining projects. In return the State must pay for its share of a project’s ‘sunk costs’,
i.e. the amount of exploration and development expenditure incurred in the project.

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If the State exercises its right to obtain an interest in a project, it may acquire a ‘carried
interest’. That is, it will be ‘carried’ by the other participants and its share of accumulated
exploration, capital and ongoing operating costs will be paid for out of its share of production,
known in this context as ‘foregone production’. Interest is also paid out of foregone
production on the outstanding amount owned (and tabled in the hands of the recipient
companies). Once the ‘accumulated liability’ of the State has been extinguished, or paid for,
it then has the right to take delivery of its share of production, and will, from then on, be
required to contribute towards operating costs of a project in the normal way.

The State has been required, from 1995 onwards to grant free equity in resource projects to
landowners from the area in which a project is located. The landowner share in projects,
which is 2% for petroleum projects and 5% for mining projects, is controlled by a state
nominee company managed by Mineral Resources Development Ltd (MRDC). The state
nominee company is expected to pay tax in the same way as the other participants in a project.

Fiscal Stability

Resource project agreements, from 2001 onwards contain a clause ensuring that the fiscal
terms in operation at the start of a contract will not be changed for the duration of the project
financing, or 20 years, whichever is lesser. This is to ensure that a resource project does not
become subject to additional taxes or imposts once a contractual agreement has been signed
which may affect the overall terms will cover the sales of ‘foundation’ volumes of gas. If,
however, the foundation volumes (of 4.858 TCF of gas) have not been sold after 20 years, the
State may relax fiscal stability terms if it is affected by serious economic and budgetary
problems at the time.

Resource companies that wish to benefit from fiscal stability terms will, from 2003 onwards,
be liable to add a 2% premium to the rate of income tax applicable to project income during
the period of stabilisation.

GST Provisions

As a general rule supplies made by mining and petroleum producing companies are zero-rated
for GST purposes because their output is exported. Consequently, they do not charge GST
on their sales and they receive a credit for expenditure on inputs. The supply for goods and
services to mining and petroleum companies, whether supplied locally and from overseas, are
zero-rated. Hence no GST is payable on these supplies.

Agents who purchase goods, including imports of mining and petroleum producing companies
are zero-rated for GST purposes provided that ownership of the goods goes directly to those
companies. It is not sufficient for goods to be purchased in order to fulfil a contract for such
companies. In those cases, GST will be payable in the normal way and a credit for the input
tax allowed to the supplier.

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Stamp Duty Provisions

The transfer of an interest in a mining lease or a petroleum development licences is subject to

stamp duty of 2% of the value. The transfer of an exploration licence, or an interest in an
exploration licence, including farmins*, is subject to a flat amount of stamp duty of K10, 000.
K10, 000 is also payable for transfer of information and the value of the information is usually
represented by the historical (actual) cost of exploration expenditure transferred to the
purchaser. However, where the price paid exceeds the historical cost of exploration, stamp
duty is paid on the additional amount – on an ad valorem basis (2% for amounts over K100,
000). For example, in the case of development licences, allowable capital expenditure (ACE)
will be mostly subject to 2% stamp duty.

*A ‘farm in’ takes place when a party gains an interest in a licence in return for undertaking
an agreed exploration program or work commitment.

Stamp Duty – Acquisition of Interest in Land

Division 10A of the Stamp Duties Act which deals with the acquisition of interests in land
owning by private corporations, referred to as “land-rich provisions” has been amended so
that the amount of duty on the acquisition of an interest in the private corporation which holds
an interest on a resource development license or resource exploration licence is the same as
duty payable on a direct transfer of assets. Prior to this amendment a direct transfer of an
exploration licence and related information attracted stamp duty of K20,000. However, the
rate of duty on the indirect transfer was 5% of the unencumbered value of the resource
exploration licence. The rate is now 2%.

Ramu Nickel Project Incentives

In the 2007 Budget the government has announced various incentives to all joint venturers
engaged in the Ramu Nickel Project, including a tax holiday in respect of any taxable income
generating from the project.

All the taxable supplies in respect of this project have now been included in zero rated
category for GST purposes.

Stamp duty rate has been reduced to nil in respect of transfer of licences, shares or interests
associated with the Ramu Nickel Project.

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Self-Assessment Exercise 2

Question 1

Calculation taxable income for the following company involved in a petroleum project
(paying tax at 50%). (All figures in millions)

Sales income: 70m

Other assessable income: 5.5m
Share of operating expenses of the project: 22m
Sole costs (overheads of the company): 5.2m
Interest: 1.4m

Exploration:
Written down value of allowable exploration expenditure: 60m
Written down value of common exploration pool (Section 155N): 15m
Additions during the year: 3m

Allowable capital expenditure:

Long life asset pool (start of year): 0m (historical cost)
Additions during the year: 82m

Short life asset pool (start of year): 45m (written down value)
Additions during the year: 6m

Question 2

Assume a petroleum company (subject to tax payable at 50%) and a mining company had the
following taxable income figures (US$ millions). Deductions do not include any Section
155N deductions.

Petroleum Company Mining Company

Sales 1200 Sales 1200
Deductions 800 Deductions 800
Taxable income 400 Taxable income 400
Tax payable @ 50% Tax payable @ 30%

The (undeducted) balance of the exploration pool (Section 155N) was 500m. All of this
expenditure was in relation to one exploration licence in which a total of 600m exploration
expenditure was incurred and all of this expenditure was incurred after 1 January 2003.

a. Calculate the Section 155N deductions for both companies and recalculate tax payable
in both cases.

b. If the (undeducted) balance of the exploration pool were 300m instead of 500m, what
would the Section 155N deduction be for the petroleum company and the mining
company?

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c. If a development licence is created from the exploration licence, whose exploration
expenditure makes up the expenditure in the exploration pool, explain the treatment of
expenditure to be transferred out of the exploration pool in the case of both the petroleum
and mining company.

Question 3

The following resource company operating in a petroleum project provided the following
figures in its tax return. Figures are in US dollars. Tax Rate is 30% (for incentive rate
petroleum operations).

• Sales income: 107.5m

• Interest income: 2m
• Share of project operating costs: 15m
• Sole costs (overheads): 4m
• Petroleum royalties (to be calculated)?
• Petroleum development levy (to be calculated)?
• Interest expense: 1.5m
• Section 219C prescribed infrastructure development expenditure: 1.5m. Assume there
are no infrastructure development expenditure.
• Exploration expenditure: AEE written down balance: 80m
• (Section 155N) Exploration pool: written down balance (Start of year) 60m. Additions
during year: 8m
• Allowable capital expenditure:
Long life asset pool (start of year): 60m (historical cost): 42m (undeducted balance)
Additions during the year: 10m
Short life asset pool (start of year): 70m (undeducted balance)
Additions during the year: 8m

Royalties and development levies are based on sales less 79% (for transport and processing
costs). Estimated remaining life of production: 8 years.

Calculate taxable income and net tax payable.

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Answers to Exercises

Question 1

Assessable income: 75.5m

Allowable deduction
Operating costs: 22m
Sole costs 5.2m
Interest 1.4m
AEE 15m
Section155N Exploration deduction 1.5m
ACE 20.95m
Total deductions 65.65m
Total income 9.85m

Notes:

AEE : Deduction is 25% of 60m

ACE : Deduction is: long-life assets – 10% of 82 = 8.2m; short life assets – 25% of 51m = 12.7m
Total 8.2m + 12.75m = 20.95m
Section 155N deduction (this should be calculated last): work out tax payable before this deduction is
included.
It is 5.47m. In order to reduce tax payable by .54m, the Section 155N deduction should be 1.1m
(rounded up).

Question 2

a.
Petroleum Company Mining Company

Taxable income 400 Taxable income 400

Tax payable 200 Tax payable 120
Section 155N deduction: Section 155N deduction:
10% of tax payable 20 25% of tax payable 30
Therefore, S155N deduction Therefore, S155N deduction
(20/.5) 40 (30/.30) 100

Note that when the Section 155N deduction is included, taxable income decreases by
40m for petroleum, from 400m to 360m; and decreases by 100m, from 400m to 300m.

b. Assuming the (undeducted) balance of the exploration pool was 300m, instead of 500m,
the Section 155N deduction for the petroleum company would remain the same, at
400m. However, the deduction for the mining company would be 72m, which is 25%
of the exploration pool (300m), which is lower than the figure – 100m – which reduces
tax payable by a mining company by 25%.

c. In the case of the petroleum company, the undeducted balance of expenditure, i.e.
460m (500m less 40m), may be transferred out of the exploration pool, which may
then be amortised as EE. There would then be a nil balance in the pool, since the
company has only one exploration licence. For the mining company, the full amount
of exploration expenditure incurred, i.e. 600m, may be transferred to the development
licence as the exploration expenditure was all incurred after 1 January 2003. The
undeducted balance of 400m (500m – 100m), may remain in the pool and be claimed

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 as Section 155N deductions. In this way a double deduction is available for mining
companies if a development licence arises from an exploration licence.

Question 3

Taxable income ($ millions)

Sales income: 107.5
Interest income: 2.0 109.50

Less:
Operating costs 15
Sole costs 4
Development Levy 2
Interest 1.5
AEE 20
ACE (7.25 + 19.5) 26.75
Section 155N exploration 4.03 73.28

Taxable income 36.22

Tax payable @ 30% 10.87
Less – royalty tax credit 2.00
Less section 219C credit 0.82
Net Tax Payable 8.05

Notes:

1. It is assumed the interest income is assessable income from petroleum operations

2. Royalty and development levy calculation: 107.5m x .93 x.02. Where both the levy and
royalty is payable, Section 161A provides that the amount paid in excess of 2% of
wellhead value of production is deemed to be tax paid – therefore a deduction is not
allowed for the royalty component, however, it is allowed as a tax credit.

3. ACE deduction for long-life assets is additions divided by 8 (estimated life of

production) 1.25m plus 6.0m which is the historic cost divided by 10 (this is a greater
deduction than dividing the undeducted balance by 10). The ACE deduction for short-
life assets is the residual balance of 78m divided by 4.

4. Section 155N (which should be calculated last) based on 10% of tax payable (1.208 –
before this deduction included) which is less than 25% of exploration pool.

5. The Section 219C tax credit in respect of prescribed infrastructure tax development
expenditure cannot exceed the lesser of 0.75% of assessable income or the expenditure
actually incurred. In this instance 0.75% of assessable income is 0.82m which is less
than the expenditure incurred of 1.5m. As there are no carry forward entitlements from
prior years, the tax credit is limited to 0.82m.

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Self-Assessment Test

Question 1

The tax regime for resource projects is, for the most part, ring-fenced. This means:

a) A company must declare all its income in its tax return.

b) Only income and expenditure in relation to a particular project are included in a tax
return

c) No exploration or other expenditure outside of a project may be claimed as ad deduction

d) With few exceptions, only project related income and expenditure may be included in
the calculation of taxable income in respect of the project

Question 2

Allowable exploration expenditure:

a) May be amortized by a divisor of four each year or by the number of years remaining
for the project

b) Consists of a pool of exploration expenditure incurred in an exploration or development

licence

c) Should be reduced by amounts claimed as an outright deduction under Section 155N

d) May be claimed as a deduction regardless of when the exploration expenditure was

incurred

Question 3

A petroleum company, paying 50% tax, has a pool of exploration expenditure from which it
may claim a deduction under Section 155N. The undeducted balance of the pool is K100
million. In a particular year its tax payable (before the Section 155N deduction) is K75
million. It is entitled to claim a deduction under Section 155N amounting to:

a) K7.5 million

b) K15 million
c) K25 million

d) K62.5 million

Question 4

Refer to question 3. If the above company were a mining company, what would be the correct
answer?

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Question 5

Which of the following statement relating to allowable capital expenditure (ACE) is correct?

a) ACE and AEE expenditure is amortized in the same way

b) Expenditure on short-life assets may normally be amortized at a faster rate than

expenditure on long-life assets

c) ACE includes capital expenditure and excludes exploration expenditure

d) Capital expenditure in a resource project may only be amortized in accordance with the
ACE provisions

Question 6

Additional profits tax:

a) is a tax based on the overall profitability of a resource company

b) may apply when the rate of return of a project exceeds a certain level

c) no longer applies to any resource projects in PNG

d) will normally be triggered at the start of very successful projects

Question 7

Interest:

a) payable by companies in exploration and development licences is an allowable

deduction

b) earned by an exploration company is assessable income

c) incurred by a resource company in a development licence may not be wholly deductible

d) incurred by a resource company during the development of a mine is deductible in the

year incurred.

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Question 8

According to the provisions of the infrastructure tax credit scheme (Section 219C), if a
company spent K10 million on tax credit projects, it could claim a tax credit (assuming
sufficient assessable income and income tax otherwise payable):

a) in the year the expenditure was incurred and over the following two year

b) equal to .75% of tax payable

c) over the following two years

d) equal to .75% of taxation income

Question 9

If the State acquires a ‘carried interest’ in a resource project:

a) it must first pay a lump sum for its share of all costs.

b) it is entitled to receive its share of production immediately.

c) it is required to pay tax on its share of production.

d) it pays for its share of total costs out of its share of production.

Question 10

If a petroleum company surrenders a petroleum exploration expenditure in respect of that

licence:

a) Must be written off.

b) Cannot be sold to another resource company.

c) May be transferred to a development licence.

d) May be transferred to any affiliated company.

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Answers: Self-Assessment Test

Question 1

The correct answer is (d). The tax regime for resource projects in Papua New Guinea is, with
few exceptions, ringfenced. This means that, with one or two exceptions, income and
expenditure only in connection with a particular project may be included in a tax return. The
main exception to the ring fence principle is Section 155N, which allows some exploration
expenditure outside a project outside a project to be claimed as a deduction against income
from that project.

Question 2

a) is correct. (b) is incorrect because exploration incurred in a development licence is

allowable capital expenditure. (c) is not correct for mining projects since it is possible to claim
a double deduction for exploration claimed under Section 155N. (d) is incorrect. There is a
time limit of 20 years beyond which exploration expenditure cannot be claimed.

Question 3

It may claim as a deduction the lesser of 25% of the exploration pool (K25 million) or an
amount which would reduce tax payable by 10% (75m/10/.50 = K15 million). (b) is therefore
the correct answer.

Question 4

If the company were a mining company, in order to reduce tax payable by 25%, the Section
155N deduction would be K62.5 million. (75 / 4 / .30). As 25% of the pool is less than
62.5million, the deduction would be limited to 2% of the Section 155N pool which is K25
million (c) is therefore correct.

Question 5

a) is incorrect. Long-life assets that are ACE are amortized over a longer period (except for
new mining projects). (b) is correct. (c) is incorrect because exploration within a development
licence is treated as ACE. (d) is incorrect because the normal depreciation provisions may
instead be applied.

Question 6

(c) is the correct answer as APT no longer applies.

Question 7

a) is incorrect because interest is not an allowable deduction for companies operating in

exploration licences. (b) is incorrect. If an exploration company earns interest or other
income, accumulated exploration is reduced by that amount. (c) is correct. Interest paid in
respect of that portion of loans, which exceed a debt to equity ratio of 3:1, is not deductible.
(d) is incorrect. Interest incurred during the development of a mine must be capitalised to the
cost of the development in accordance with Section 68(5) of the Act.

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Question 8

a) is correct. the expenditure incurred can be claimed as an income tax credit in the year it is
incurred and over the following 2 years provided that there is sufficient assessable income
and income tax otherwise payable. (c) is therefore incorrect. (b) and (d) are incorrect because
the annual amount that may be claimed should normally not exceed .75% of assessable
income.

Question 9

a) is not correct because the State pays for its share of costs out of its share of production –
which means (d) is correct. (b) is incorrect because its share of production is used to repay
the State’s debt. (c) is incorrect – the State is not liable to pay tax on its share of production
unless it is held in a company or other legal entity which is separate from the State.

Question 10

(a) and (b) are incorrect because exploration expenditure may be transferred to a development
licence or sold to another resource company upon the surrender of a licence. Hence (c) is
correct. d) is incorrect since exploration expenditure may only be sold to an affiliated
company which has a development licence.

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10. TAX ADMINISTRATION

Learning Objectives

After you have successfully completed the work in this unit you should be able to:

• Describe the tax obligations of group employers and employees.

• List accounting Records which Businesses must keep for Tax Purposes.

• List those persons required to submit a Tax return.

• Explain Tax Assessments and Conditions under which they may be Amended
by the IRC.

• Describe penalties which may be imposed in relation to Tax Returns.

• Describe procedures which permit Taxpayers to appeal against a Tax Assessment or

Decision of the IRC.

• Explain the regulations, known as the Income Reporting System, which are
designed to ensure that building contractors and others pay tax on income
received.

• Explain the Regulations Governing the Registration and Control of Tax Agents.

• Explain how the Training Levy Operates.

Group Employer Obligations (Section 299G)

Each employer is required to register with the IRC as a Group Employer within seven days of
beginning to employ staff. Each registered group employer is given a group number. That
number should be used when any letters or payments are sent to the IRC.

A sole trader may also employ staff and as such is subject to the normal group employer
obligations.

A group employer must pay to the IRC by the seventh day of each month, the amount of the
salary or wages tax deduction from the earnings of its employees during the preceding month.
For example, all salary or wages tax collected in January should be submitted no later than 7th
February. A remittance advice form must be submitted with the salary or wages tax payments
giving details of wages paid to each employee and deductions made. If there has been no
salary or wages tax deduction, the form should still be returned, endorsed ‘Nil”.

A group employer who does not remit tax deductions to the IRC on time may be liable to a
penalty of 20% of outstanding tax payable. In addition, interest of 20% per annum (pro-rated)
on the tax payable and the flat penalty amount (until paid), is payable. Penalties may be
remitted (dropped) on application.

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Example

A group employer should have remitted tax amounting to K2,500 on 7 March. It is not
remitted until 31 March. If the IRC penalises this employer, the penalty would be calculated
as follows:

(K)
20% x K2,500 500.00
20% x K3,000 (2,500 + 500) x 24/365 39.45
Total Penalty 539.45

A group employer who fails to submit salary or wages tax collected is liable to a fine of
between K500 to K5,000 and/or imprisonment for up to six months. Because of the penalties
involved, employers should put aside salary or wages tax deducted from employees until due
for payment to the IRC. This is not the employer’s money and as such should not be used by
an employer to meet cash flow shortages.

Statement of Earnings

At the end of each year, a group employer must prepare a statement of earnings for each
employee which sets out gross earnings for the year, including any allowances and benefits,
and total amount of salary or wages tax paid. Other information such as address, number of
dependants and period of employment must also be provided. These statements should be
issued to employee not later than 14 February of the following year or within seven days in
the case of an employer’s termination.

A group employer should submit to the IRC by 14 February each year, a copy of statement of
earnings issued to each employee (together with all used and cancelled (spoiled) statements).
In addition, a reconciliation statement should be prepared and submitted reconciling the total
amount of salary or wages tax deducted according to the statement of earnings and the actual
amount remitted to the IRC. If there is a difference between the two amounts, a full
explanation for the difference must be given. Common reasons for discrepancies between
monthly remittance and annual reconciliation would be failure of the employer to actually
remit the tax, or over or under deduction of some employees’ tax.

Statement of Earnings forms are supplied to employers by the IRC. Employers should obtain
a copy of the booklet “Procedures for Group Employers/Paying Authorities’ issued by the
IRC which provides details of what is required of them in the collection of salary or wages
tax deduction.

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Employee Obligations

Salary or Wage Tax Declaration Form (Regulation 66)

As stated earlier, employees should complete a declaration form, obtainable from their
employer, and submit it to their employer in order to benefit from dependants’ rebates. Details
of any employer allowances/benefits must also be stated on the declaration. The original form
is sent to the IRC with the next monthly remittance of tax. A copy of the form is retained by
the employer and may be referred to, to ensure that the correct amount of tax is deducted from
the employee’s salary or wage.
A declaration may be submitted to only one employer at a time. If an employee has more
than one employer, he should loge a declaration with his main employer. A new declaration
should be submitted to an employer when an employee:

• commences employment with that employer.

• begins to maintain a dependant who was not included on the previous declaration.

• stops maintaining a dependant who was included on the previous declaration; or

• receives additional (or less) employer allowances/benefits to those listed on the previous
declaration.

Once a tax declaration form has been submitted, claims for dependants will be taken into
account at the end of that pay period. However, a new declaration may not be used to
recalculate tax for fortnights that have already passed.

For this reason, it is important for employees to submit a declaration immediately when they
begin work with a new employer.

Liability for Unpaid Salary or Wages Tax

Prior to the 2011 Budget changes, under the Income Tax Act 1959, an employer who failed
to remit salary or wages tax in relation to its employees was liable to pay the amount of unpaid
tax together with any additional penalties that may be imposed (refer Section 299J). Where
the employer is a corporate entity, this recovery mechanism can only be effective to the extent
that an employer is sufficiently solvent to meet the total amounts outstanding.

From 2012, Division 2AB was amended to create personal liability for unpaid salary or wages
tax for the directors of a company, to ensure a higher standard of group tax compliance. Under
Section 299AD, on or before the due date of each group tax payment, the directors shall cause
either the correct amount of tax to be paid, an arrangement to be made for deferred payment
with the Commissioner General, or the corporate employer to be placed into liquidation.

Where the required amount of group tax is not paid, each director of that company is jointly
and severally liable to the extent of the shortfall.

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Division 2AD prescribes the manner in which the Commissioner General may collect amounts
from the directors of an employing company. Broadly, the Commissioner General must
provide 30 days’ notice of the intention to recover the outstanding amounts.

The penalty will not be imposed on the director of the company if within this timeframe:

1. the liability of the employer is discharged.

2. a payment plan in agreed; or

3. the employer company has commenced the process of winding up.

Income Tax Returns

Employees are not normally required to submit an income tax return at the end of the tax year.
However, they must submit a return for any one of the following reasons:

• their non-salary income exceeds K100.

• they wish to claim a tax rebate for work related or other allowable expenses.

• they wish to claim a tax rebate for education fees.

• they received allowances [having been granted a (Section 299E) Variation] which have
not been taxed.

The form to be completed is Form A and this may be obtained from the IRC. A copy of the
employee’s statement of earnings should also be submitted with the return.

Where a claim is made for a rebate for a work-related expense (under Section 214), the
lodgement of the return is treated as a lodgement of an objection. The actual assessment was
made when the employer deducted tax from fortnightly earnings. It is therefore essential that
returns be lodged on time (i.e. within 60 days after end of tax year) for the objection to be
treated as received in time.

Maintenance of Accounting Documents by Taxpayers

Some taxpayers fail to maintain adequate books of account for their business, because of
ignorance of good administration, or lack of financial resources to hire the services of an
accountant. But often times it is a deliberate attempt to evade the payment of tax.

The Income Tax Act (Section 364) provides that any person who carries on a business in
Papua New Guinea, shall keep in the English language, books of account adequate enough to
enable the IRC to assess the taxpayer. Where any person liable to tax refuses to keep adequate
accounting records for the purposes of assessment, the IRC may by notice in writing specify
to the taxpayer the types of books, records and documents that the taxpayer ought to maintain.
They may also be liable to a penalty payment.

The Act also requires each business to preserve accounting records and documents for a
minimum period of seven years. They may be stored electronically.

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Tax Returns and Assessments

The following taxpayers are required to submit a tax return:

• any individual whose gross non-salary income exceeds K100 (Form A to be submitted);

• any individual who runs a business or is engaged in a profession and whose gross income
exceeds K100 (Form B to be submitted);

• all companies (Form c to be submitted); and

• all partnerships (although not taxed as such), business groups, trusts and superannuation
funds.

Tax returns should be submitted two months after the end of the year of income or when
submitted by a registered tax agent, up to seven months after the end of the year of income.
Tax agents normally have to lodge returns progressively over a period up to 31 August. For
example, by 30 June, 75% (of taxable returns) must be lodged. From income tax returns, and
from other information, the IRC shall make an assessment of the amount of taxable income
of the taxpayer and the tax payable on that income (Section 228). An assessment means the
ascertainment of the amount of taxable income and of the tax payable on that income.

An assessment will usually be issued by the IRC within 3 to 4 months of submission of the
return. Tax should be paid within thirty days after the date of assessment. In the case of
individuals earning business or non-salary income, that tax need not be paid before the 30
September following the end of the year of income.

Amendment of Assessments (Sections 232-239)

The IRC may amend an assessment by making such alterations or additions which it considers
necessary, even if tax has already been paid on the assessment. An amendment may be made,
for example, to correct an error or omission, to allow a credit for tax paid, or in the case of tax
evasion.

Under Section 24, where a taxpayer’s liability is reduced as a result of an amended assessment,
a taxpayer may receive a credit against other income tax, withholding tax, or salary or wages
tax payable, or receive a direct refund for tax overpaid.

Where a taxpayer has made a ‘full and true disclosure’ of all the material facts necessary for
the IRC to make an assessment, an amendment (to increase or reduce tax liability) may only
be made within:

• 3 years from the date in which tax became due and payable under the assessment; or

• 6 years for salary or wages tax.

Where a taxpayer has not made a full and true disclosure of all the material facts
necessary for the IRC to make an assessment and there has been an avoidance of tax,
the assessment can be amended:

• at any time, where the avoidance of tax is due to fraud or evasion.

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• in any other case, six years from the date in which tax became due and payable under
the assessment.

Nil Assessments

From 1 January 2013, a Nil Assessment will be recognised as an assessment. This will ensure
that taxpayers with Nil Assessments are afforded the same certainty and fairness as those with
positive assessments.

Under the ITA, a Nil Assessment is a statement from the IRC which states that no tax is
payable. However, a Nil Assessment will not be an assessment of the quantum of losses a
taxpayer can carry forward. This means losses will be reviewed when claimed as a deduction
by the taxpayer against future income, and the IRC will have 3 or 6 years to review the losses
from this point in time.

Prior to 1 January 2013, while the ITA recognised taxpayers with a taxable income and tax
payable as an assessment, there was no provision which clearly allowed for a Nil Assessment
to be an assessment. The effect of this was that the time limit for the amendment of a tax
return may not apply.

Penalties (Sections 312-341)

Penalties may be imposed on taxpayers for late filing of returns, late payment of taxes, failure
to supply a return or providing false information in a return.

Section 316 provides for either 100% of the tax assessable or K100 for each month late. The
IRC has power to remit (drop) these penalties in part or full. In practice additional tax for late
lodgement is usually calculated at 20% on tax outstanding from the due date for lodgement.

Penalties for not disclosing taxable income, for claiming allowable deductions or rebates for
which one is not entitled, may be up to 200% of the tax which the taxpayer has attempted to
avoid. The IRC can start court proceedings in order to recover taxes it considers should have
been paid.

Under Sections 317-322, fines of between K1,000 and K50,000 may be imposed on taxpayers
deliberately providing false information in returns or making false answers to questions put
by the IRC.

Tax Audits

The IRC has a limited number of officers involved in investigation taxpayers. The efforts of
the investigators are generally directed towards specific taxpayers whose affairs have come
to the attention of the IRC, rather than at all taxpayers on a random basis.

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Investigations usually involve the audit of tax returns filed for the last three to five years and
may concentrate on any particular areas of the firm’s previous tax returns. Investigations
often focus on companies regularly achieving a trading result that would by normal standards
be regarded as an unacceptable return on capital invested.

Tax Evasion

Under Section 361 - ‘Contracts or arrangements to evade tax’. The Income Tax Act grants
the IRC arbitrary assessing powers where it considers the assessable income of taxpayers to
be less than it should be in the circumstances.

Garnishee Notices

Under Section 272 – ‘Commissioner General may collect tax from person owing money to
taxpayer’ – the IRC may serve garnishee notice on any person believed to hold money for a
taxpayer. Garnishee notices are most commonly served on commercial banks in order to
obtain money directly from a taxpayer’s bank account in settlement of a debt in respect of
taxes owed, penalties, etc.

Appeal Procedures (Sections 245-258)

A taxpayer who is dissatisfied with an assessment may lodge an objection with the IRC. This
objection must be lodged within sixty day after the assessment has been served. Even if the
IRC is willing to accept an objection after sixty days has passed, it is not permitted to do so
under the Income Tax Act. Therefore, it is extremely important to ensure the objection is
lodged within the sixty-day time limit. An objection will not be valid unless it states fully and
in detail the grounds upon which the taxpayer disagrees. Moreover, it is not possible to add
further grounds at a later date. Consequently, the drafting of a notice of objection is a matter
requiring careful consideration.

The IRC will then consider the objection and may allow it in full, in part or disallow it entirely.
A considerable time period may elapse between the lodgement of the objection and the receipt
of the IRC’s decision.

Appeal or Review (Section 247 & Sections 55-6)

A taxpayer who is still dissatisfied with the decision of the IRC may, within sixty days after
service of such decision, either:

• refer the decision to the Review Tribunal for review; or

• treat the objection as an appeal and refer it to the National Court.

The advantage of the Review Tribunal is that the proceedings are reasonably informal and
may be relatively inexpensive in comparison with a court hearing. If a taxpayer (or the IRC
itself) is not satisfied with a decision of the Review Tribunal, it may refer the matter to the
National Court, or the Supreme Court, but only (in the latter case) if the decision of the Review
Tribunal involves a question of interpretation of the law.

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Income Reporting System (Sections 3541-354ZA)

The Income Reporting System (also known as business income payment tax deduction
system) provides for tax to be deducted by those payers who make taxable business payments,
when those payments are made. So, for example, when contractors receive payment for work
or services performed, a withholding tax should be deducted from the payment. If, however,
the contractor has a certificate issued by the IRC to show that he is a regular taxpayer, the
withholding tax will not apply. Either way, the system ensures that tax will be paid on the
payment made.

The relevant legislation affects businesses if they are payers and or recipients of business
payments for work in the following industries:

• Buildings and construction – including repairs, painting, fitting of built-in furniture and
any other building or construction activity
• Repair and maintenance of any vehicle – or motor vehicle component, including
painting, panel beating, etc
• Road transportation – of any goods and materials
• Provision of security services

The system also applies to non-work arrangements such as hire and lease of equipment or to
other arrangements by which assessable income is carried. But it does not apply to contracts
for the sale of goods.

Paying Authorities

A business that makes a taxable business payment is required to register as a paying authority
with the IRC. Upon registering, the paying authority is required to:

• Obtain a Certificate of Compliance from the business it enters into a contact with and to
which payments will be made. A contact in this context has a wide meaning which
would include all normal business arrangements, verbal or written. If a business does
not produce a Certificate of Compliance, the paying authority should deduct 10%
withholding tax from payments made.

• Provide the IRC with an annual income reporting statement detailing all contracts where
taxable business payments exceed K500.

• Maintain a register of all taxable business payments, whether more or less than K500.
This register should be available for inspection by the IRC if required, which could be
at any time. It should be kept for a period of seven years after the transactions or
contracts were completed.

Failure to comply with any of the above requirements could result in penalties being
imposed on the paying authorities.

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Payee

A taxpayer who enters into a contract with a paying authority is a ‘payee’ for purposes of this
system. A payer who receives or its likely to receive a taxable business payment shall first
have been issued with a Certificate of Compliance by the IRC. These certificates will be
granted provided the taxpayer is registered with the IRC for tax purposes (i.e. has a tax file
number) and is up to date with its payment of tax and submission of tax returns. If the payee
does not have a Certificate of Compliance, they should ensure that 10% withholding tax has
been deducted from all business payments received.

Where a contract and payment proceed without the production of a certificate of compliance,
and the paying authority has not deducted 10%, both the registered paying authority and payee
are liable to pay a penalty.

Tax Agents (Sections 342-353)

Registration of Tax Agents

A person, partnership or company wishing to be registered as a tax agent can make an

application to the Registrar of Tax Agents (located in Department of Finance and Planning).
Applicants should have appropriate accounting qualifications and experience in the tax
industry. If the Registrar is satisfied that the applicant is fit and proper to prepare income tax
returns and conduct discussions with the IRC in relation to such work, he will register the
applicant as a tax agent. Where a partnership or company is registered as a tax agent, a
member shall be registered as a nominee of the partnership or company. This will be every
member of a partnership, but in the case of a company it will be a particular person (or person)
specified in the applicant.

The Registrar of Tax Agents will register applicants as a tax agent of a particular class.

Class Permitted Function

A Preparation of Salary and Wages Income Tax Returns

B Preparation of Income Tax Returns (other than partnership, trust and company returns)
declaring income as for Class A registration and investment income (e.g. from shares or
property). This, therefore, excludes preparing the tax return of any business.

C Preparation of Income Tax Returns (other than partnership, trust and company returns)
declaring income as for Class B registration and income from a business.

D Preparation of Income Tax Returns as for Class C registration and the preparation of
partnership and trust returns. This refers to any business except a company.

E Preparation of Income Tax Returns of any kind declaring income of any kind.

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If there are any changes in the constitution of an accounting partnership, the Registrar of Tax
Agents must be notified. If a nominee of a company which is registered as a Tax Agent ceases
to be employed by the company or, if that nominee becomes a director, manager or other
administrative officer of the company, the Registrar of Tax Agents must be notified.

A person will cease to be a nominee of a partnership or company if they cease to be a member

of the partnership or company, or where the Registrar of Tax Agents considers the person to
be not a fit and proper person to be a nominee.

Tax Agents Circular

All persons acting as Tax Agents should receive from the IRC a copy of the Tax Agents
Circular which is issued each year. This can be obtained from the Tax Agent Liaison Officer
(tel: 322 6786). This pamphlet contains information on lodgement requirements for the year
in question, as well as other useful information. As already stated, tax agents are allowed to
submit returns for their clients on a staggered basis throughout the year, i.e. a certain
percentage of returns must have been submitted by a certain time.

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Self-Assessment Exercise

Question 1

A group employer has employed six workers (all residents) and pays them the following
wages or salaries during the month of September 2012.

Employee Salary / Wage per fortnight Dependants

K
A 460 3
B 575 2
C 757 4
D 1,080 1
E 1,200 3
F 2,500 4

A. Calculate how much salary or wages tax should be deducted each fortnight in total.

B. In the month of September, the pay fortnights are week ending 8th September and 22
September. When should the tax deducted during these fortnights be remitted to the
IRC?

C. If the tax collected during September is not remitted to the IRC until 10 November,
calculate the fine that may be payable.

Question 2

A small company submitted a tax return 18 months late. In the return, the company failed to
declare income of K3,000, and claimed deductions totalling K5,500 which tax auditors found
to be false. The company’s accountants examined the assessment (for tax payable of
K55,000), and three months later lodged an appeal against the assessment. Their fees for this
work amounted to K3,000.

A. Calculate what penalties the taxpayer would be liable to pay.

B. What allowable deductions are available in respect of accountancy fees charged for
examining the tax assessment?

C. Do you think the appeal against the assessment would be successful?

D. If the taxpayer refused to pay the amount assessed, what action would be available to
the IRC?

Question 3

A taxpayer had inherited money six years ago and had not disclosed receiving this
money in his tax return at the time. State if the assessment raised at the time can be
amended now.

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Question 4

ABC Business signed a contract with a major resource company to overhaul the company’s
plumbing system. It also supplied back-up spares to the company intended to last for a number
of years. The invoice submitted by ABC business was as follows:

• Fees for overhauling plumbing system K100,000

• Cost of spare parts K 45,000

State how ABC Business would be taxed on the above contract if (a) it possessed, and
(b) it did not possess a certificate of compliance.

Question 5

A firm employs a workforce which has an annual salary or wages bill of K2.4 million.
During a year of income, the firm employs a staff training officer whose annual salary
is K59,500. Four employees whose annual wages total K80,000 are sent to Lae Technical
College for a six months course. The fees payable and other expenses total
K17,000. Other training expenses, including training consumables and depreciation
of in-house training facilities amount to K8,000.

Calculate allowable deductions in respect of salary and wages and training

expenditure, and net training levy payable, if any.

Question 6

A coffee producing and exporting company carried an accounting net profit of K5,000,000 in
2012 year of income. You are also provided with the following information:

• Interest received from Papua New Guinea financial institution of K63,750 (net of
withholding tax).

• Rental income received on residential property let out was K450,000. The property was
purchased at the start of the year with a ten-year bank loan. Depreciation of 2% was
claimed on the building. Costs associated with the property and its purchase were:

 management fees K25,000

 repairs K15,000
 bank interest K40,000
 loan establishment fees K19,000
 conveyancing costs K20,000

• Dividend income received from foreign subsidiary was K1,500,000.

• Legal expenses included:

 debt collections K15,000

 court fines K 8,000
 appeal against tax assessment K24,000

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• Equipment for the processing of coffee beans was purchased for K560,000 in June.
Depreciation of 15% was claimed for the half year.

• Two employees, each earning K28,000 per year attended a full-time training course for
six months, at a technical college. The company also employed a full-time training
officer whose annual salary was K32,000.

• A director of the company visited Germany, an important source of its export income to
seek new trade contacts and contracts. The company estimated that 75% of expenditure
of K100,000 incurred was directly related to its export business.

• Loans of K20,000 to employees which were written off.

• Contributions of K80,000, being 7% of taxed wages and salaries of employees to

NASFUND. The company also contributed K100,000 being 15% of senior managers’
salaries, to an approved overseas superannuation fund.

Calculate taxable income and tax payable by the company.

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Answers to Self-Assessment Exercise

Question 1

A.
Employee Salary / Wage per fortnight Dependants Tax
K K

A 460 3 9.82
B 575 2 30.14
C 757 3 (allowed) 55.12
D 1,080 1 164.38
E 1.200 3 177.31
F 2,500 3 (allowed) 1,065.21

B. Tax payable by 7 October.

C. Tax paid 34 days late. The employer is liable to pay the following fine:

K
1,065.21 x 20% 213.04
1,278.25 x 20% x 34/365 23.81

Total 236.85

Question 2

A. The taxpayer may be liable to pay a penalty for late submission of tax return. Section
316 provides for either 100% of the tax assessable or K100 for each month late,
whichever is greater. For not disclosing taxable income and for claiming allowable
deductions for which one is not entitled, the penalty could be 200% of tax that the
taxpayer is trying to avoid. The penalty in this respect could therefore total K5,100
(8,500 x 2 x 30%).

B. Accounting fees incurred in objecting to a tax assessment are not allowable deductions.

C. No. The appeal would not be considered because it must be lodged within 60 days of
the assessment having been issued.

D. The IRC can take any taxpayer to court for non-payment of tax. Alternatively, it has the
power to have money withdrawn directly from taxpayer’s bank account by serving a
‘garnishee notice’ on the taxpayer’s bank.

Question 3

Money received from an inheritance would be taxable in Papua New Guinea, so there
would be no question of the assessment being amended.

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Question 4

(a) If ABC Business had a certificate of compliance, it would not be subject to any business
payments withholding tax. It would include the income received – K1445,000 – in its
income tax return. It would also include all costs associated with performing the
contract as allowable deductions.

(b) If ABC Business did not have a certificate of compliance, withholding tax amounting to
10% of K100,000, i.e. K10,000, would be withheld from the payment received. Note
that no withholding tax would be payable in respect of supplying spare parts. The
business payments withholding tax only applies to contracts where services are provided
(or items leased), not goods supplied.

ABC Business should later include the income received in their tax return. They would
receive a credit for the business withholding are already paid.

Question 5

Training levy payable: 2,400,000 x 2% = 48,000

Salary and wages = 2,400,000

Staff training officer = 59,500 (additional deduction)
Wages of employees on training course = 40,000 (additional deduction)
Fees and other expenses = 17,000
Other training expenses = 8,000
Total allowable deductions (for tax purposes) = 2,524,500

Training expenses, calculated at the normal rate, amount to K124,500. Since this
exceeds the training levy payable of K48,000, no levy is payable.

Question 6

Net profit before tax 5,000,000

Add: Non-Deductible / Assessable Income

Interest income – grossed up amount 11,250

Loan establishment fees 19,000
Conveyancing costs 20,000
Court fines 8,000
Tax appeal 24,000
Depreciation – coffee processing equipment 42,000
Super-Contributions – Non-Resident Fund 100,000
Loans to employees 20,000 244,250
5,244,250

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Less: Deductible / Non-Assessable Items

Loan establishment fees 3,800

Conveyancing costs capitalised – depreciation 400
Coffee processing equipment 560,000
Training costs 60,000

Export promotion costs 75,000 699,200

Taxable income 4,545,050

Tax payable at 30% 1,363,515

Less credit for interest withholding tax (15%) 11,250

Less dividend rebate (1,500,000 x 30%) 450,000 461,250
Net Tax payable 902,265

Notes:

1. 15% withholding tax on interest initially paid.

2. Loan establishment fees may be claimed over 5 years.

3. A deduction has not been claimed for tax appeal costs. However, in some cases it may
be possible to argue the cost qualifies as a deduction under Section 68(1).

4. Conveyance costs should be capitalised, and depreciation claimed.

5. Equipment used in primary industry may be written off 100%.

6. Double deduction for training expenses. Note that these expenses will have been
claimed once already. This expenditure will also qualify as a credit against the training
levy of 2% imposed on the company if its payroll exceeds K200,000.

7. Export promotion expenses qualify for double deduction. Again, these expenses will
have been claimed once already.

8. Loans to employees not allowable because the amount not previously included as
assessable income. However, if the loans were written off because of the employment
relationship a deduction should be allowable under Section 68(1) of the Act.

9. Superannuation contributions to a non-resident fund are non-deductible.

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Self-Assessment Test

Question 1

An amendment increasing a taxpayer’s liability can be made in a case where there has not
been (deliberately) full and true disclosure of all material facts:

a) within 6 years of the date the assessment was due and payable.

b) within 3 years of the date the assessment was due and payable.

c) at any time.

d) none of the above.

Question 2

An objection must be lodged against an income tax assessment with which a taxpayer
is dissatisfied:

a) within 30 days of the date of service of notice of the assessment.

b) within 60 days of the date of service of notice of the assessment.

c) within 90 days of the date of service of notice of assessment.

d) by the 7th day of the month following the issue of the assessment.

Question 3

If a person is dissatisfied with a decision by the IRC in relation to an objection, then he

or she can lodge an appeal with:

a) the IRC.

b) the National Court.

c) the District Court

d) the Consumer Affairs Tribunal.

Question 4

An amendment decreasing a taxpayer’s liability can only be made by the IRC:

a) within 60 days of the service of notice of the assessment.

b) within 3 years of the date the tax on the assessment was due and payable.

c) within any time, limit.

d) if directed by the Review Tribunal.

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Question 5

The Income Reporting System requirements apply to the following type of income:

a) payments of salary and wages income.

b) payments to non-residents undertaking contracts which are deemed to be for prescribed

purposes.

c) payments by a liquidator of a company.

d) payments for the provision of professional services.

Question 6

By February 14 each year, a group employer must supply to the Internal Revenue
Commission:

a) a list of all employees.

b) a copy of all statements of earnings issued to employees.

c) group tax payments for the previous year.

d) none of the above.

Question 7

Failure to produce a Certificate of Compliance will mean:

a) late payment penalty applies to the payment.

b) withholding tax is deducted from the payment.

c) a person is fined an amount not less than K200 and not exceeding K2,000.

d) the party making the payment will be subject to withholding tax.

Question 8

A tax agent must be:

a) registered in order to be able to charge fees.

b) solvent because he will be deregistered if he is insolvent.

c) a fit and proper person according to the Registrar of Tax Agents.

d) all of the above.

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Question 9

One of the following is not a qualifying training expense (for the purpose of the training levy):

a) depreciation of capital equipment used in training.

b) cost of running an approved training institution.

c) salaries of full-time training officers.

d) salaries of university lecturers while lecturing staff in a full-time professional training

course.

Question 10

A double deduction is allowed under Section 72A for the following:

a) salaries paid to full time training officers.

b) cost of consumables in a training department.

c) cost of on the job training department.

d) all of the above.

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Answers: Self-Assessment Test

Question 1

(c) is correct. There is no time-limit during which the IRC may amend an assessment where
the taxpayer has deliberately withheld material information.

Question 2

(b) is the correct factual answer (Section 245) and the others are simply incorrect.

Question 3

(b) is the correct answer because an appeal from a decision can only be taken to either the
Review Tribunal or the National Court. The other bodies have no jurisdiction over tax
disputes.

Question 4

(b) is the correct time-limit which applies in the circumstances. (a) is a time period which
refers to the lodgement of an objection against an assessment. (c) is simply incorrect. (d) is
incorrect because the IRC does not need the approval of the Review Tribunal to amend an
assessment.

Question 5

(d) is correct. The other answers are all specific exclusions from the business payments tax
(income reporting) system.

Question 6

b) is the correct answer.

Question 7

(b) is the correct answer.

Question 8

(d) is the correct answer because all these statements are true.

Question 9

(d) is not a training expense and all the others are set out in the legislation as qualifying
training expenses. In this case also, an employer would have no way of measuring this cost
i.e. in (d).

Question 10

(a) is the correct answer. A double deduction is allowable only for salary and wage expenses
related to staff training.

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11. GOODS AND SERVICES TAX (GST)
Learning Objectives

After you have successfully completed the work in this unit you should be able to:

• Understand that GST is a tax levied on the value added at each stage of production or
supply.

• Explain how GST is charged on taxable supplies and GST credits are claimed on inputs
on which GST has been paid.

• Distinguish between taxable supplies, zero-rated supplies and exempt supplies.

• Explain the purpose and use of tax invoices.

• Describe the procedure for submission of GST returns and payments.

• Explain specific GST provisions, which apply to particular economic sectors and
taxable activities.

What is Goods and Services Tax?

The price of most goods and services includes a tax on the supply of those goods and services
which is called ‘goods and services tax’ (GST). This tax is levied on the gross value of the
supply with a credit allowed for the GST paid on inputs used to make the supply. The practical
impact of this is that GST is collected at each stage of economic contribution made by anyone
in connection with any activity of a business or commercial nature. However, the tax cost of
GST is borne by the ultimate consumer of the goods or services and as a general proposition
GST is not a cost to business. The rate of GST is at present 10% (Section8).

The GST legislation is contained in the Goods and Services Tax Act 2003. Sections referred
to in this unit are sections of the Act (and not the Income Tax Act). The GST legislation
replaced the Value Added Tax Act 1998. Except for the change in name, the GST legislation
is almost identical to the Value Added Tax Act.

Businesses charge GST on goods and services (taxable sales) which they sell to customers.
They (the businesses) will have paid GST on their inputs (taxable purchase) – the materials
and supplies they purchased to make their goods or required to provide their services. They
will receive a credit or refund for GST paid on their inputs. The following example illustrates
in a simple manner how GST works:

Goroka Ltd has a forest plantation. It sells K10, 000 of timber to Hagen Ltd who
will turn the timber into handcrafted furniture. Goroka Ltd chares K10, 000 for
the timber and adds on 10% to the invoice for GST. The total, which Hagen Ltd
pays, is K10, 000 for the timber plus K1, 000 GST, which is K11, 000 in total.
Goroka Ltd pays the K1, 000 collected to the IRC.

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 Hagen Ltd makes 100 tables from the timber. These are sold on to a furniture
shop owned by Sepik Ltd and it is charged K250 for each table plus GST. On the
invoice this is shown as K25, 000, plus K2, 500 GST. Hagen Ltd claims back the
GST charged by Goroka Ltd which is K1, 000 and hands over the GST paid to
Sepik Ltd, K2, 500. This means a net payment of K1, 500 is made to the IRC.

Sepik Ltd sells the tables at a price of K500 plus GST of K50. It received in total
for the tables, K50,000 plus GST of K5,000. When Sepik Ltd does its GST return,
it claims back the K2,500 paid to Hagen Ltd, and hands over the K5,000 GST paid
by the customers, which is a net payment of K2,500.

Purchase Sales GST Returns

K K Details K
Goroka Ltd
- Forest Owner
Timber sold for 1,0000 Output Tax 1,000
Plus GST 1,000 Less: input tax 0
Total Sale 111,000 Paid to IRC 1,000

Hagen Ltd
- Manufacturer
Timber made into tables and sold
Purchases 1,0000 Sales 25,000 Output tax 2,500
Plus GST 1,000 Plus GST 2,500 Less: Input tax 1,000
Total Purchase 27,500 Total Sale 27,500 Paid to IRC 1,500

Sepik Ltd
- Retailer
Tables sold to consumers
Purchases 25,000 Sales 50,000 Output tax 5,000
Plus GST 2,500 Plus GST 5,000 Less: Input Tax 2,500
Total Purchase 27,500 Total Sale 55,000 Paid to IRC 2,500

Consumer
Purchases 50,000
Plus GST 5,000
Total Purchase 55,000

From the above example one can see how the net amount of GST payable to the IRC for a
taxable period is calculated: output tax less input tax.

Output Tax = GST collected on all sales made

Input Tax = GST paid on all purchases

Taxable Activities (Section 10)

For GST purposes. A taxable activity is an activity carried on continuously or regularly. It

involves the supply of goods and services to others for a consideration (normally money) but
not necessarily for a profit. Setting up in business is part of the taxable activity, as is the
closing down and sale of a business. It does not include an activity carried on essentially as
a private recreational pursuit or hobby.

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Persons and organisations that carry out taxable activities are normally required to register for
GST purposes and collect GST from their customers. This includes ordinary businesses,
traders, professions, clubs, societies and charities. All government bodies, whether
departmental or statutory, national, provincial or local government level, are required to pay
GST on all purchases and charge GST on any sales.

Taxable Supplies

GST is charged at 10% on what are called taxable supplies. The taxable supply to goods and
services includes all normal sales transactions. In the example given in this unit, the timber
sold by Goroka Ltd, the tables sold by Hagen Ltd and the tables sold by Sepik Ltd to the public
would be all table supplies.

Example of taxable supplies of services include:

• Professional advice by legal or accountancy firms.

• Vehicle and other repairs.

• Facilities and entertainment provided by clubs for which membership fees are paid.

• Local authorities’ services for which rates are charged. [Local authorities are deemed
to supply goods and services consisting of sewerage, garbage and night soil collection
[Section11(9)].

Taxable supplies also include imports of goods and services (Section 6). In most countries
where GST operates, the destination principle applies. This means that goods and services
are taxed where they are received or consumed. So, imports are taxed here, but exported
goods and services are not subject to GST.

The GST on imported goods is calculated based on the landed value of goods, which may
include freight and insurance. It may also include other duties paid or payable such as import
or excise duties (Section 6(2)). GST on imported goods is collected and paid in the same way
as customs duty.

Imports of services are taxed in the same way as imported goods. Examples would include:

• computer or accounting services carried out overseas for a Papua New Guinea firm.

• management fees and other service charges paid by a Papua New Guinea firm to an
overseas entity.

In these cases, the Papua New Guinea business is deemed to have made the supply. This is
called a reverse charge on services received from abroad (Section 14). The effect of the
reverse charge rule is that the PNG purchaser is deemed to have an output tax amount
payable of 10% of the amount paid for the services and an input tax deduction of the same
amount. As the two offset each other in practice the reverse charge rule has no application
except to those who make exempt to those who make exempt supplies such as banks and
other financial institutions.

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Refer to specific GST provisions in this unit for more detailed information on taxation of
supplies.

Not all goods sold are subject to GST. Some are either ‘zero-rated’ or ‘exempt’ from tax.

Zero-Rated Goods and Services (Section 19)

Goods and services which are zero rated are not subject to GST when sold. In addition, any
GST paid on purchases required for the supply of such zero-rated goods or services will result
in an input tax deduction or refund. Usually this will be applied as a credit against GST
payable on taxable activities. However, in certain circumstance were there are no GST or
other taxes against which to offset this credit, it will result in a refund.

All exports are zero-rated in Papua New Guinea, in line with the ‘destination principle’. This
includes manufactured products, primary products, petroleum and minerals, seafood and fish
caught in Papua New Guinea, and boats sold to recipients who export them out under their
own power. An exporter will not charge GST on his or her sales overseas but will still be able
to claim an input tax deduction on inputs bought to produce the goods or services. Exporters
must register for GST purposes in order to obtain tax credits on inputs. All goods exported
must be ‘entered for export’, pursuant to the Customs Act [Section 19(1)]; i.e. they must be
listed on the export entry form and given to Customs division of IRC.

Other goods and services which are zero-rated include:

• International transport of passengers to and from Papua New Guinea (and ancillary
associated services such as loading, handling and insurance) [Section 23(1)]. However
airborne and maritime transport of passengers within Papua New Guinea is subject to
GST.

• Ships or aircraft stores for use outside Papua New Guinea [Section 19(1)(h)].

• Sale of a business as a going concern (Section 20).

• Medical supplies, including prescription glasses supplied by a registered doctor or

optician [Section 21(1)(a)].

• Refined gold, silver or platinum sold by a refiner to a dealer in metal or a jeweller

[Section 21(1)(b)].

• Duty free goods. Tourists may also purchase goods from any retailer and request will
be zero-rated (Section 7).
• Travel by sea or air and temporary accommodation in PNG but only where the supply
was purchased while the intending traveller was outside PNG [Section 21(I)(g)].

Refer to specific GST provisions in this unit for more detailed information on certain supplies
that are zero-rated.

Exempt Goods and Services (Sections 24 - 25)

No GST is charged on exempt supplies, but the seller does not get an input tax deduction or
refund for the GST included in the price of the purchases made to supply the goods or services.
In Papua New Guinea health and education services are exempt from GST. Therefore,

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doctors, dentists, hospitals and other health services are exempt from charging GST on the
services they provide. But they are not able to recover GST paid on their inputs. However,
since most of their required medical supplies will be zero rated, the negative impact of this
will be minimal.

Other activities, which are exempt, include:

• Certain financial services, which includes all normal banking transactions, life
insurance, superannuation and stock exchange transactions. However, note that the
provision of financial advice (or other advice) is subject to GST. (Section 24) & [Section
25(i)].

• Supply of public road transport (such as rural and urban PMV’s and Taxis) [Section
25(7)(d)].

• The supply of betting, lotteries or games of change – e.g. poker machines [Section
25(7)(a)].

• Postage stamps [Section 25(7)(d)].

• Housing or a motor vehicle provided to an employee in the course of their employment.

In other words, employers cannot claim any GST input credits in respect of the provision
of these items [Section 11(13)].

Refer to specific GST provisions in this unit for more detailed information on certain supplies
that are exempt.

GST Based on Inclusive Price

As earlier stated, all goods subject to import duty or excise duty are also subject to GST.
Imported alcohol and tobacco are subject to exercise duty and customs duty, as well as GST.
These duties are first calculated and then GST is calculated on the total amount.

Example: The land cost (C.I.F.) of fresh fruit being imported is K500. Import duty of 55%
is payable on this amount and 10% GST, calculated as follows:

Import duty: K500 x 55% = K275

GST is charged on K775 (500 + 275) = K775 x 10%
GST on importation = K77.50

Prices to be shown inclusive of GST (Regulation Section 29)

Any person registered for GST must, when displaying, quoting or advertising prices of goods
or services sol by him, show or quote those prices inclusive of GST charged. In other words,
prices must include GST.

GST Registration (Sections 43 – 51)

Under Section 43 firms with sales (actual or expected) exceeding K250,000, over a 12-month
period, must register with the IRC for GST. They are then required to charge GST on the sale
of any goods and services. The advantage is that they can claim an input tax deduction GST
paid on their inputs – on purchases and expenses incurred in making taxable supplies. Firms

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that sell less than K250,000 may register if they wish [Section 43(5)]. A firm that is not
registered will lose out because they cannot claim a credit or refund for GST paid on their
inputs.

Note that the mining threshold is K250,000 of taxable supplies. This does not include supplies
exempted from GST or outside the scope of GST. Thus, for example, a doctor or dentist,
providing health services, would not normally be required to register.

Persons wishing to register for GST should obtain registration form from IRC (or from an
accountant). Upon receipt of details, GST registration number will be provided by IRC, which
then enables someone to issue tax invoices and to charge GST on goods or services supplied.

Non-Profit Bodies

Non-profit bodies must also register for GST, if they reach the threshold limit of K250,000 of
taxable supplies. Most charitable organisations, sports clubs, service organisation, churches,
social clubs and school committees are non-profit bodies.

However, [Section 3 (8)] non-profit bodies have a special registration option where each
branch or division can be treated as a separate entity to determine if the K250,000 registration
threshold limit is exceeded. Only those branches or divisions which exceed the threshold,
need register. Each branch or division must maintain its own accounting system and be in a
separate location or carry out different activities.

Group Registration (Sections 48 – 51)

A company or entity that has a number of branches or associated companies may register
separately for each branch or company, or as a group and submit one GST return for the whole
group. To register as a group, companies must have the same shareholders whose common
voting interest is at least 90%. A wholly owned subsidiary would clearly satisfy this test and
thus can also be included in a group with the parent company or other subsidiaries of the same
parent company.

In the case of group, the whole group must be looked at to determine if the registration
threshold has been exceeded (unlike non-profit bodies).

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A partnership must register for GST rather than the individual members of the partnership.
Also, groups of individuals may register as a group for GST purposes.

Accounting for GST (Section 27)

The GST is generally invoice based using ‘tax invoices’ to document GST due on sales as
well as GST paid on inputs.

• GST from taxable supplies is included in the GST return at the earlier of invoicing or
when payment is received.

• GST incurred in making supplies is also included in the GST return at the earlier of
invoicing or when payment is made [Section 16(I)].

The GST payable will be the difference between the tax collected or due on the sale of outputs
(output tax) and the tax on inputs (input tax). For certain businesses such as small retail traders
or for some small sales, where it may not be practical to issue invoices for every sale, the GST
will be based on cash sales or on a combination of cash and invoice sales. Credits for GST
paid on inputs that cost more than K50 will be allowed only if a tax invoice can support the
credit. There should be a receipt for supplies of less than K50, though a tax receipt is
preferable.

Although GST is normally accounted for on an accruals (invoice) rather than a cash
(payments) basis, if taxable sales do not exceed K1,250,000 annually approval can be sought
to use a cash basis. Businesses operating on an accrual basis may be liable to pay GST on the
sale of goods even if money has not yet been received from the sales. Likewise, GST payable
on inputs may be claimed before payment for the goods, provided that a tax invoice has been
received. With the invoice system there is a much greater need to collect payment from
debtors on a timely basis because GST on sales has to be paid straight away.

If a business experiences a cashflow problem by using the accruals basis, the GST division of
the IRC may permit the business to return GST on a cash basis – even if the 1,250,000-
threshold limit may have been exceeded.

Tax Invoices (Section 39)

As stated above, a tax invoice should be issued for all supplies over K50. A tax invoice is not
required for supplies less than this, however, some evidence should be obtained to show that
the amount has been paid. Tax invoices are similar to other invoices, but the words ‘Tax
Invoice’ must be clearly printed on the invoice. The GST registration number must also be
clearly printed. For supplies over K200, the purchaser’s name should also appear on the tax
invoice.

On all tax invoices it is also necessary to state the amount of GST being charged, or
alternatively, the following words must be written: “The invoice is GST inclusive” or “This
invoice includes GST charged at 10%’”. Where the GST is included in the price, the GST is
simply 1/11th of the total amount. This is known as the tax fraction. The tax fraction means
the fraction calculated in accordance with the following formula:

a/(100+a) where “a” is the rate of GST. (as the rate of GST is 10% the tax fraction is 10/110
= 1/11)

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Example

Goods were supplied for K8,250, GST inclusive. GST payable (already included in the price)
would be: K8,250 / 11 = K750.

Credit Notes [Section 40(1)]

A supplier issues credit notes when the price of the supply is reduced after a tax invoice was
issued. This could be for several reasons but one of the most common is for the return of
faulty goods. The information required on a credit note is very similar to that required for a
tax invoice. However, there must be also a brief explanation of why the credit note is being
issued. The date and the number of the original tax invoice must be included so that there is
a clear audit trial.

A credit note issued in respect of a sale already previously returned to the IRC will result in
less GST payable – similar to a GST input tax deduction. If the adjustment occurs in the same
taxable period, only the net amount of GST in respect of the original tax invoice and the credit
note (or the net supply) needs to be included in the GST return.

Debit Notes [Section 40(3)]

Debit notes are usually issued where the invoice price has increased after the original tax
invoice has been issued. Debit notes are very similar to credit notes in terms of what is
required to be disclosed on the debit note. As with credit notes, an adjustment will be required
in the GST return when a debit note has been issued. Debit notes have the effect of increasing
the amount of GST to be returned to the IRC.

Tax Invoices Issued by Agents (Section 59)

Agents may also buy or sell goods or services on behalf of their principal. In such a situation
the principal is still the buyer or seller for GST purposes and the principal is deemed to receive
the supply and not the agent. If, however, the agent is also registered for GST, a tax invoice
may be issued to (or by) a tax agent in his name.

A registered agent can also receive supplies for a non-resident principal and claim any GST
incurred on behalf of the principal for importing goods to Papua New Guinea or exporting
goods from here, or for arranging the importing or exporting of goods from Papua New
Guinea.

Apportionment [Section 31(14)]

Apportionment is required where a registered person makes a mixture of taxable and exempt
supplies. For example, a finance house may provide certain financial services, which are
exempt, and also supplies business advice, which is subject to GST. GST inputs will only be
allowed in respect of providing advice.

Therefore expenses, such as rent, telephone costs, will have to be apportioned as only GST
paid on expenses that relate to the firm’s business advice services may be claimed.

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Similarly, if a social club also provides poker machines, GST incurred to provide and maintain
the poker machines will not be allowed as a GST input credit, as the supply of games of chance
is an exempt supply. The rest of the club’s activities may be fully taxable, and so input credits
may be claimed.

Record Keeping Requirements (Section 107)

Businesses are required to keep supporting GST documentation for a fixed period of time –
seven years – in common with other tax documentation, to allow audits of their GST payments
to be carried out by the IRC. If an IRC investigation is being carried out the IRC can extend
the original 7-year period by a further three years.

At the very minimum tax invoices should be kept serving as proof of payment and proof of
earnings. If a tax invoice is not held when an IRC audit is conducted, and a copy cannot be
obtained, it is likely that the IRC will disallow any input credit, which has been claimed.

The private sector should have an accounting system, which records purchases each month
and the amount of GST paid on those purchase (including imports or either goods or services
where the importer is liable to pay the GST). That system also needs to differentiate between
items bought for personal use and items bought for business use, as GST input credits are
allowable only for items used for business.

Preparing Accounts on a GST Inclusive or GST Exclusive Basis

Taxpayers have the option of preparing accounts on a GST inclusive or GST exclusive basis.
If the accounts are GST inclusive, the figures in the Profit and Loss will include the GST and
there is no need to have a separate GST account in the Balance Sheet. Most unregistered
persons and small businesses prepare GST inclusive accounts.

If accounts are prepared using a GST exclusive basis, the figures in the Profit and Loss will
exclude the GST. The GST component is posted to a separate GST account in the Balance
Sheet. The treatment of revenue and expense items should be consistent. Only the debtors
and creditors figures in the balance sheet are GST inclusive. No matter how the accounts are
prepared, a note should be included in the accounting policies advising of the basis used.

Submission of GST Returns (Sections 63-66)

Firms registered for GST must submit a GST return to the IRC 21 days after the end of each
taxable period, normally one month. Firms with annual taxable supplies of less than K625,000
may apply for an extended taxable period of up to 6 months. GST that is payable is due on
the same day as the return is due to be filed. At the end of each taxable period the GST return
form should be completed.

It will show the total sales (fewer exempt sales) and the GST charged on taxable sale – known
as output tax or GST payable. A further item will be the input tax deductions claimed – known
as input taxes, - which should be supposed by a list of the invoices (or import entries if
applicable) for input purchases.

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This will show the value of each purchase, the GST paid on that purchase and the vendors
GST registration number, name and invoice number (ensuring that input credits are claimed
only once). Businesses which are able to demonstrate that their accounting systems are
sufficiently developed to capture all input credits will be exempted from supplying a list of
input credits claimed.

When GST returns are submitted, supporting invoices for credits claimed will not need to be
attached but will need to be kept. This is to support credits claimed in case of an audit by the
IRC. If at an IRC audit a business cannot produce the invoices in support of the input credits
claimed, those credits will be disallowed, leaving it with a bill to pay for that amount.

The IRC carries out regular audits of GST payers, to ensure that they are paying the correct
amount and that they are claiming only the correct input credits. At the end of the year the
IRC may cross check the sales and purchases claimed each month with the annual sales shown
in the income tax returns.

Penalties

In the case of late payment of GST, additional tax is payable at the rate of 10% on the amount
owing, and 20% calculated on an annual basis Section 85(1). Penalties are payable for
attempted fraud or avoidance, or offences under the GST Act (Section 95). Penalties range
from a fine of K5,000 for a first offence to a maximum fine of K50,000. Following an
amendment to the Act, a summons may now be served through the post, rather than directly
to the person. It is the responsibility of the taxpayer to inform the IRC of any change of
address.

Objections

Dispute settlement producers are similar to those for income tax, with provisions to object to
the assessments raised by the IRC and to appeal against the disallowance of an objection to
the Review Tribunal or the National Court. Objections to assessments should be made within
two months of the assessment being issued, though the Act Section 74(I) allows this time to
be extended.

Sales in More than One Province

If a firm carries on business in more than one province, the correct amount of GST payable to
each province must be calculated. Only one return needs to be lodged for a firm’s countrywide
activities. However, the net amount payable on the return should be divided in the same ratio
as gross sales in each provide for that month are to total sales for the month.

Example

A firm carries on business in NCD, Morobe and Eastern Highlands. Gross sales for the month
were K450,000. Total net GST payable for the month (after calculation of the input credits)
was K9,000.

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To calculate GST payable to each province, you should:

1. Divide total GST payable by the taxable sales: 9,000/450,000 = .02

2. Multiply .02 by the amount of sales in each province.

Assuming sales in each province were as follows, GST payable would be calculated in the
following way:

Province Sales GST Payable

NCD 200,000 K4, 000

Morobe 170,000 K3, 400
Eastern Highlands 80,000 K1, 600
Totals 450,000 K9, 000

Specific GST Provisions Affecting Economic Sectors

Mining and petroleum sector (Section 21(1)(d))

As a general proposition supplies by mining and petroleum exploration and producing

companies are zero-rated for GST purposes because their output is exported. Consequently,
they do not charge GST on their export sales and they receive a credit for expenditure on
inputs including imports (but excluding motor vehicles).

The supply of goods and services to mining and petroleum companies, whether supplied
locally and from overseas, are zero-rated. Hence no GST is payable on these supplies (with
the exception of small-scale mining lease operators). There is no need to pay in the first
instance and then claim a refund.

A company having an exploration/production licence but not actively engaged in operations

(an inactive license holder) does not qualify the company for zero rating on its supplies.
Drilling companies and others supplying goods and services to the resource sector do not
charge GST on their supplies to the resource companies, but they must pay GST on goods and
services they acquire. This means companies which predominately provide services or sell
goods to resource companies are usually in a GST refund position.

Agents who purchase goods, including imports, on behalf of mining and petroleum producing
companies are zero-rated for GST purposes provided that ownership of the goods goes directly
to those companies. It is not sufficient for goods to be purchased in order fulfil a contract for
such companies.

A company, which purchase goods and services for use in a project which qualifies as a tax
credit under the infrastructure tax credit scheme is technically not entitled to receive those
supplies as zero-rated. In practice this would be difficult to administer as the supplier may
not be in a position to determine the use of the goods or services supplied. Consequently, a
company using goods for infrastructure tax credit scheme purposes which were zero-rated at
the time of purchase should self-assess the GST and include this as output tax in their GST
return. The GST would be calculated on the purchase price of the goods or services.

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Primary Producers

Unregistered primary producers or suppliers who sell to registered buyers may increase their
prices by 1%. This is to enable them to recover, more or less, GST paid on their inputs. The
buyer is then permitted to claim an input tax credit for the extra paid to the farmer or supplier.

In the case of large producers or plantations, GST will be charged on sales to processors or
exporters, and credits for GST paid on inputs can be directly claimed.

From 2004 onwards, coffee exporters will pay GST, otherwise payable to suppliers, directly
to the IRC. The supplier’s GST account in the IRC will be credited with the amount paid.
This arrangement was made necessary by the failure of many coffee suppliers to pass on GST
collected on sales to exporters.

Timber Industry

Export sales of logs and woodchips, sawn or processed timber are zero-rated. The local sale
of logs and sawn timber (or timber which has undergone processing or manufacture) is subject
to GST, and so input tax deductions may be claimed.

Specific GST Provisions Affecting Supply of Goods and Services

Aid-funded Projects

Government approved aid-funded projects are exempt from local taxes under the terms of
various aid agreements. To be government approved, the aid project in question must have
been given designated aid project status by Department of Foreign Affairs.

To account for GST, aid providers (e.g. AusAID) are zero-rated and if they appoint an agent
as a principal contractor then the principal contract is zero-rated on the income it receives
from their aid provider. The principal contractor will pay GST on all supplies and will claim
the GST paid back in its monthly GST return. It is the aid provider or principal contractor
that is zero-rated on the income. Zero rating does not apply to any other company, sub-
contractor, etc on the project.

Bad Debts (Section 35)

If GST has previously been paid supplies for which payment has not been received, an input
tax credit can be claimed in respect of any bad debts, which are written off in a taxable period.
Any amount subsequently recovered is treated as a taxable supply and consequently GST is
payable on that amount.

Business – Sale of a Going Concern (Section 20)

The sale of a business as a going concern is zero-rated if the supplier and purchaser are
registered for GST at the time of transfer. It is possible to sell a portion of an existing taxable
activity as a going concern as long as the portion can be run as a separate taxable activity. But
the sale of individual assets of a business is subject to GST.

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Capital Goods

Businesses are able to claim a tax credit for GST paid on capital equipment. The input tax
deduction will be offset against GST payable by the business. If the input tax deduction in
any one month exceeds the GST payable, the input tax should be refunded immediately.

Education [Section 25(5)] & [Section 31(16)]

Education services provided by (GST registered) education institutions are exempt. Although
education goods such as textbooks and school stationery are not exempt, they are not subject
to GST if imported by schools. And if they are purchased from a local supplier, schools are
entitled to a GST refund. In both case (for goods to be exempt) a charge for books and
education supplies must be included in the school fees. If sold directly to students in a school
shop GST would be payable.

Employment Benefits [Section 25(7)(e)]

GST is required to be paid on the cost (or tax value) of employment benefits, excluding cars
and accommodation (which are exempt and therefore input tax deductions cannot be claimed).
Employers are entitled to claim input tax credits in respect of reimbursements of actual
expenditure incurred by an employee in the course of an employer’s business. Such expenses
would include use of a residential phone if used for business purposes, transport and hotel
accommodation while travelling on business, etc.

Government Supplies

All government supplies of goods and services are taxable. This includes payments for
electricity, telephone and water supplies. Rates are subject to GST as local authorities are
deemed to supply goods and services consisting of sewerage, garbage and night soil
collection.

Charges for permits, e.g. driver licences, business permits, motor vehicle registration or visas
are not subject to GST. Certain other Government charges, such as court fines, and the sale
of postage stamps are also exempted. The reason why some government supplies are taxed,
and some are not is as follows. If a good or service is, or could be in the future, supplied by
the private sector, it should be subject to GST. This is to avoid giving the government any
cost or price advantage over private sector competitors, which would distort competition. It
should be noted that government purchases are also subject to GST.

Hire Purchase [Section 16(7)]

Hire purchase and other instalment purchase arrangements result in GST being paid on an
instalment basis. GST is payable only on the principal (not the interest) part of each payment.
The amount of GST payable per instalment will be the same proportion as the instalment
payment (principal component) bears to the total sale price.

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Insurance

All insurance policies are subject to GST (except life insurance), whether private or business
policies. Businesses can claim an input credit. Businesses must pay GST on any insurance
payouts at 1/11th of the amount received. In other words, insurance companies must deduct
an amount equal to the tax fraction (1/11) from any payouts made.

Land and Property

The GST treatment of land, housing and immovable property is one of the more complicated
issues in the theory and practice of GST. The treatment varies in different countries.

Under Section 12, the sale of land is not subject to GST. However, for GST purposes the sale
of land does not include the transfer of buildings or other improvements which may be situated
on the land. When a section is sold which includes land and other improvements the sale price
must be apportioned between the land and the improvements. The value of the land shall not
be greater than the last unimproved capital valuation provided by the Department of Lands or
a valuation provided by a registered valuer. The portion that relates to improvements will be
subject to GST.

For all property sales, a recent valuation by a registered valuer is required (and two in the case
of commercial property) which separately shows the value of the land and the value of the
improvements. The IRC may request an additional valuation by a valuer of its own choice if
there is any doubt. Note that the valuation of a property for GST purposes may not be the
same as the actual sale price.

The construction (and maintenance) of property is subject to GST. That is, GST is payable
on cement and other inputs. If someone is GST registered and uses the building for business
purposes, or sells the building, GST inputs may be reclaimed. But no inputs may be claimed
if used by the person for private use.

GST will apply on the sale of residential property by a taxable person, unless that property
has been privately used by the vendor. GST will not apply if an unregistered person sells
private or commercial property. However, if a registered person purchases property from an
unregistered person and uses it in a taxable activity, they can claim an inputted one-eleventh
of the purchase price as a deemed input credit (under the second-hand goods provisions
[Section 30(2)]. For example, a registered person may purchase a private house and rent it
out as an accommodation or as an office.

Note that a personal property that is part of a business sold as ’a going concern’ is zero-rated.
Property, which is being let (rented out) at the time of sale, may be treated as a ‘a going
concern’.

Rental and lease payments for offices, warehouses and other commercial property, and
residential accommodation are subject to GST. Property owners must be registered for GST
otherwise no GST may be charged or input credits for expenses claimed. But employers who
provide accommodation for their employers cannot claim an input credit for GST paid on
costs (e.g. rent) associated with provision of the accommodation.

Note that the sale or transfer of land is subject to stamp duty. For stamp duty purposes, land
includes land and improvements such as buildings.

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Lay-by-Sales [Section16(4) and (5)]

For lay-by-sales the time of supply is when ownership of the goods passes to the buyer,
normally when the final payment has been made. This is when the GST, which will have
been collected in instalments, will be paid to the IRC. The purchaser, if registered for GST,
will be entitled to claim a full input tax credit at this stage.

Leases (of Equipment, etc)

Leases, like hire purchase agreements, are also deemed to be a series of supplies for GST
purposes. However, GST applies to the gross lease payment. This means GST applies to both
the principal amount and to any interest or finance charges.

Motor Vehicles [Section 31(11)]

A business cannot normally claim an input tax deduction for a car, whether purchased within
the country or imported. No input tax deductions are available for vehicles (except
commercial vehicles) unless you are a dealer in motor vehicles or vehicle operator. Input
deductions are available for commercial vehicles, which may be a truck utility, van (minimum
capacity – one tonne) or a bus (minimum capacity – 9 passengers).

Lease payments made on commercial vehicles will include GST. This GST can be claimed
bac as the expense is incurred. Leases on non-commercial vehicles will also incur GST on
the lease payments but as non-commercial vehicles are exempt GST paid on a lease cannot be
claimed back.

Newspapers [Section 25(7)(b)]

The retail supply of newspapers is an exempt supply and therefore not subject to GST, but
GST is payable by the distributors who sell to retail outlets and newspaper sellers.

Overseas Services (Section 13)

Services performed outside Papua New Guinea subsidiary to its overseas parent. GST is
payable in addition to the fees charged. This amount should be returned to the IRC as a GST
output tax debt. However, as noted earlier the recipient would be entitled to a deemed input
tax deduction once the payment was made, if registered for GST purposes. The overall effect
of this is therefore nil. However, those who make exempt supplies, such as financial
institutions, would not be able to claim any of the deemed input tax credit. (Note that
withholding tax may be payable on management fees paid to overseas parties).

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Second-hand Goods [Section302(2)]

second-hand goods if imported for personal use are subject to GST at the point of import. If
imported by a trader, GST is payable on import and chargeable on subsequent sale. Second
had goods sold privately within Papua New Guinea after having been used here are not subject
to GST. However, if sold by a dealer, GST is levied on the difference between the cost price
and sale price.

Where a registered person buys second-hand goods from an unregistered person for resale or
use in a business, an input credit of 1/11th of the amount paid is permitted [Section 30(2)].

Temporary Imports [Section 6(5)]

You already learnt that imports are subject to GST. Temporary imports in the country for a
few days (less than 28 days) are zero-rated. But if they are intended to be here for a few
months, then a bond is payable, which also includes GST. This bond is returned if the imports
leave Papua New Guinea within one year. But if they remain any longer the bond is forfeited.

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Self-Assessment Exercises

Question 1

a. Explain what is the ‘tax fraction’ with reference to GST.

b. If the retail price of a product is K193, calculate GST payable if the price (i) is inclusive
of GST, and (ii) excludes GST.

c. If the rate of GST was increased to 15%, calculate what the tax fraction would be.

d. If the rate of GST was increased to 15%, calculate what the tax fraction would be.

e. If the rate of GST increased to 12%, calculate the GST payable on goods if the price of
the goods, inclusive of GST, was K85.

Question 2

Explain how the ‘destination principle’ applies with reference to the imposition of GST.

Question 3

Explain how GST is applied in the following situations:

a. Sale of stationery by a Papua New Guinea bookshop to (a) general public (b) a secondary
school.

b. Sale of a new motor car to a (a) taxi business, (b) a supermarket, (c) private citizen

c. Renting of accommodation by employer for employees

d. Renting of premises by a person (registered for GST) to conduct business.

e. A real estate business leases and rents out business premises and private
accommodation.

f. (1) Sale of a second-hand motor car by private person A to private person B for
K5,000. (2) Private person B seels the car to private person C at a public auction
(conducted by a licences dealer -GST registered) for K6,000. (3) Private
person C sells the car to a GST motor sales company for K4,500. The motor sales
company on-sells the car for K9,999.

g. A person running a business (GST registered) takes out three insurance policies: fire
insure for his business (k3,000), medical insurance (K1,000) for his family and life
insurance (K50 per month). His business premises are damaged by fire and he receives
K10, 000 compensation from the insurance company.

h. An entertainment centre (GST registered) was sold for K250, 000 to another GST
registered business. The centre was fully operational and no assets on the premises had
been sold prior to the sale, except two office computers for K1, 200.

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i. A New Zealander in Papua New Guinea on holiday buys artefacts of K800. He wants
to avoid paying GST on them

j. A local bookseller (GST registered) supplies books and stationery to schools as well as
the general public. One of the schools also imports educational supplies directly from
Australia.

k. A large timber company exports sawn timber, plywood, woodchips and logs. It also
sells these products locally.

l. A doctor runs a family medical centre.

m. A person purchases an air ticket from Goroka to Singapore

n. A commercial building and the land, which it occupies, are sold. The building has been
leased out over the years and used as retail outlets. It is fully tenanted at time of sale.

Question 4

A retailing business imported food products for K50, 000 (CIF). Duty payable was 35%. The
firm was registered for GST purposes.

a. Calculate the final landed cost of the products, including GST.

b. If the sale price of the goods was K90, 000 (before GST), calculate the final retail price

c. If the firm had no other sales during the month, calculate the net amount of GST payable
to the IRC.

d. Calculate the amount of GST payable to the IRC (or refundable) if the firm was
supplying (i) exempt goods (ii) zero-rated goods.

e. Explain what would happen if the firm was not registered for GST.

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Answers to Self-Assessment Exercises

Question 1

a. The ‘tax fraction’ is used to calculate GST payable on goods, the price of which already
includes GST (GST inclusive price). It is calculated in accordance with the following
formula:

a/100 + a, where “a” is the rate of GST.

b. (i) K17.55; (ii) K19.30

c. 1/7.667 (or 15/115)
d. K9.11

Question 2

Goods and services that are traded or sold internationally are subject to GST in the
‘destination’ country rather than the country of origin. These imports are subject to GST but
not exports.

Question 3

a. Normal GST payable in both cases. The school (if registered for GST) can get a GST
credit provided payment for stationery supplied was included in school fees.

b. Normal GST payable in all cases. The taxi business can claim a GST credit if it is
registered.

c. Employer must pay GST if the owner of the accommodation is registered. No GST
credit is allowed.

d. GST payable if owner of the property is registered. A credit is allowed for GST paid.

e. If the real estate business is registered, GST is charged on all leases and rentals. The
business can claim a credit for GST paid on inputs.

f. (1) No GST charged.

(2) GST is charged on difference between buying and selling price. K100 is payable.
(3) The purchaser can claim K409 as a GST credit.
(4) GST of K999,90 charged to the purchaser. GST inclusive price – K10,998.90.

g. All policies are subject to GST except life insurance. An input credit may be claimed
for GST paid on fire insurance. GST of K909 is payable on the insurance payout
[Section 11(10)].

h. No GST payable on sale. GST charged on sale of computers – K120 charged to

purchaser.

i. If the retailer packs the artefacts and sends them to the New Zealander’s home address,
they will be free of GST.

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j. GST is charged on goods sold both to schools and the general public. The schools, if
GST registered, can get a GST rebate. The school can import supplies free of GST
registered, can get a GST rebate. The school can import supplies free of GST (if GST
registered).

k. No GST is charged on the export of these products. The local sale of processed timber,
i.e., sawn timber and plywood, will be subject to GST. A credit for GST paid on inputs
will be given.

l. Services and medicine supplied by the medical centre are not subject to GST. No GST
credits are allowed in respect of expenses such as renting the premises, electricity,
telephone or water.

m. The airfare would not be subject to GST, if just one ticket for the whole itinerary were
issued. However, if a separate ticket is issued for the domestic flights, GST would be
payable on the domestic part of the trip.

n. The building is not subject to GST since it is sold as ‘a going concern’. The transfer of
ownership of land is not subject to GST.

Question 4

a. K74,250

b. K99,000

c. K9, 000 – K6,750 = K2,250

d. i) Nil ii) K6, 750 refundable

e. the firm would not receive a GST credit for K6, 750. It could not charge any GST.

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Self-Assessment Test

Question 1

The GST inclusive price of a 29-inch TV is K3, 360. The GST component included in the
price of the TV is:

a) K336.00

b) K3, 000

c) K305.45

d) None of the above

Question 2

Mrs Moulsdale conducted a garage sale and sold an old 14-inch TV to a second-hand dealer
for K300. She asks what the GST consequences are of the sale of her TV. You advise that:

a) This would not constitute a supply in terms of section 11(1) and no GST is therefore
chargeable on the sale.

b) This would constitute a supply in terms of section 11(1) and GST is therefore chargeable
on the sale

c) This would constitute a supply in terms of section 11(1). However, Mrs Moulsdale is
not carrying on a taxable activity, so the supply was not made in the course or
furtherance of a taxable activity and no GST is chargeable.

d) This would constitute a supply in terms of section 11(1), and Mrs Moulsdale is carrying
on a taxable activity, so the supply was made in the course or furtherance of a taxable
activity and GST chargeable.

Question 3

A building and the land it stand on are sold for K1 million. The building is fully tenanted, it
has in-house management, maintenance agreements etc and the purchase continues that
taxable activity of leasing the building. The vendor has approached you for GST advice. You
advise:

a) GST is chargeable on the full amount of the purchase price as the sale is a taxable supply

b) GST is chargeable only on the amount that relates to the building. But as the sale is that
of a going concern, the supply is zero-rated.

c) The sale of land and buildings is an exempt supply and no GST is therefore chargeable.

d) The sale of the building is deemed not to be a supply and not GST is therefore
chargeable. The sale of the land is a taxable supply but is zero-rated as a going concern

Question 4

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Paul purchased a 21-inch TV from a local Boroko appliance store specially to watch the Super
12 Rugby final. The consideration paid for was K620. What was the value of the supply?

a) Value = K563.64

b) Value = K600

c) Value = K620

d) None of the above

Question 5

A finance company is involved in making supplies of vehicle loans and vehicle leases. It
approaches you for advice on GST consequences of the two supplies. You advise:

a) Vehicle loans and vehicle leases are both exempt from GST.

b) Vehicle loans are exempt while vehicle leases are taxable supplies.

c) Vehicle loans and vehicle leases are both taxable supplies.

d) Vehicle loans are taxable supplies while vehicle leases are exempt.

Question 6

Peter is a painter in Port Moresby. He has his own painting and framing equipment in a studio
adjacent to his home. Peter has an arrangement with local tourist operators which ensures that
regular steams of tourists are shown his paintings in a shop also adjacent to his home. A
visitor’s book is maintained along with details of people who actually purchase Peter’s
paintings. Every six months Peter produces a catalogue of his latest paintings and sends these
to people who have previously purchased and also to the tour operators who distribute them
on his behalf. Peter’s annual income from selling his paintings is K17, 000 and he
supplements this income by lecturing on Papua New Guinea art at local educational
institutions. He approaches you for GST advice in relation to his paintings. You advise:

a) Although the painting activity is a taxable activity, Peter need not register for GST.

b) The painting activity is not a taxable activity and Peter need not register for GST.

c) The painting activity is a taxable activity and Peter is required to register for GST.

d) Although the painting activity is not a taxable activity, Peter can register for GST.

Question 7

A client of yours recovers K230 of a K330 debt previously written off. The GST deduction
previously claimed on the debt was K30. The client approaches you for advice on the GST
treatment of the bad debt recovered. You advise: -

a) There is no further GST consequence.

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b) GST output tax to be returned is K30.

c) GST output tax to be returned is K20.91.

d) None of the above.

Question 8

Your client manufactures furniture made from native Papua New Guinea hardwood. All
supplies are exported. Your client approaches you on selecting a taxable period for GST
returns. You advise:

a) Any taxable period will do.

b) A six-monthly taxable period should be selected.

c) A two monthly taxable period should be selected.

d) A monthly taxed period should be selected.

Question 9

Your client receives a GST assessment dated 13 October 20XX issued by the IRC following
and audit.

a) Forget it as the required two months to lodge an objection has expired.

b) No problem as the object would be within the three months lodgement of objection
notice requirement.

c) Although the objection is outside the two months lodgement requirement, the IRC has
a discretion to accept late objections.

d) None of the above.

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Question 10

Mr Wong an exporter of native trees complains to you that taxes on this logging business is
forcing him to apprise the viability of the business. He has heard that the Government wants
to encourage exports out of Papua New Guinea by refunding GST on production. When he
approaches you for advice you say?

a) exports are zero-rated including exports of logs in any form.

b) exports are exempt only for unprocessed logs.

c) exports are exempt for logs in any form.

d) exports are exempt only for processed logs.

Question 11

A PNG painter who has 10 paintings sold at auction in PNG receives a letter from the
auctioneers certifying that 8 of the paintings were sold to a Melbourne gallery. Subsequent
to the sale, the Australian purchaser forwards the paintings on to Melbourne. You advise the
painter that: -

a) there is no supply as the paintings were sold at auction.

b) the supply is exported and is therefore zero-rated.

c) the supply is exported but because it was sold by auctioneers in Papua New Guinea GST
is chargeable.

d) the supply is not exported, and GST is chargeable.

Question 12

If the rate of GST were increased to 12.5%, the ‘tax fraction’ would be

a) 1/12

b) 1/12.5

c) 1/10

d) 1/9

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Answers: Self-Assessment Test

Question 1

(c) is the correct answer, 1/11 of K3, 360 is K305.45 (section 2 definition of tax fraction)

Question 2

(c) is the correct answer. A supply includes all forms of supply. The sale of the TV is
therefore a supply. For GST to be chargeable, Mrs Moulsdale would have had to undertake a
taxable activity, meaning a business activity, which is carried on continuously, or regularly
(section 10). Mrs Moulsdale is not carrying on a taxable activity and therefore no GST is
chargeable. (The dealer if registered would be entitled to an input credit equal to 1/11 of
K300).

Question 3

(b) is the correct answer. the transfer of ownership of land is deemed not to be a supply and
therefore GST is not chargeable on the amount related to the land (section 12). The sale of
the building is a taxable supply but is charged at a rate of 0% as the supply is that of a going
concern (section 20).

Question 4

(a) is the correct answer as:

Total consideration K620

Includes:
Value of sale K563.64
GST at 10% K56.36

Therefore, output tax = K620 x 1/11 = K56.36 (section 18)

Question 5

(b) is the correct answer. A vehicle loan is a debt security and is exempt under section
24(1)(c) and therefore no input tax deductions in respect of making the supply are allowed.
Under the vehicle lease, the vehicle is supplied by the finance company to the lessee which
uses the vehicle in exchange for the payment of the lease rentals and therefore each lease
rental charge is a taxable supply (section 10). Input tax deductions in respect of making the
supply (for example, input tax on the acquisition cost of the vehicle to the finance company
which is in the business of hiring cars) is allowed.

Question 6

(a) is the correct answer. The painting activity is a taxable activity as it is conducted as a
business, is carried on continuously and involves the supply for a consideration of goods
(section 10). Although Peter is not required to register for GST, as the value of his total
supplies is less than K250, 000, he is able to register [section 43(5)]. Registration would mean
that peter is required to charge output tax on paintings sold and claim input tax as a deduction
in respect of costs incurred in making the supply.

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Question 7

(c) is the correct answer. The GST deduction previously given in respect of the bad debt was
K30. Therefore, the GST to be returned in respect of the bad debt recovered is 230/330 x
30 = K20.91 [section 35(4)].

Question 8

(d) is the correct answer. Exported goods are zero-rated (section 19). The client charges
GST output tax on supplies at a rate of 0% and is able to claim input tax deductions on the
costs of making the supply [section 31(3)]. Having paid GST on the purchase of materials
without having to collect GST from its customers your client will be in a net credit position
with the IRC. Your client should recover this credit from IRC as soon as possible.

Question 9

(c) is the correct answer. Unlike objections in relation to income tax assessments, the
IRC has discretion to accept late objection lodged outside the two months requirement in
respect of GST assessments [section 73(4)].

Question 10

(a)is the correct answer. Exports of logs, whether processed or unprocessed are zero-rated
(section 19).

Question 11

(d) is the correct answer. For the goods to be exported and therefore zero-rated, the painter
would have had to post the paintings to an overseas address and satisfy the conditions of the
Customs Act relating to exporting or entering the goods for export. It is not enough that the
purchaser posts the painting to an overseas address [section 19(1)(a)].

Question 12

The tax fraction would be calculated as follows: a/100 + a = 12.5/112.5 – 1/9. d) is therefore
correct.

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