SUGGESTED SOLUTIONS

SL3 – Corporate Taxation

March 2021

SL3 Suggested Solutions March 2021

 SECTION 1
Answer 01

Learning outcome/s: 3.1, 3.2 and 7.3

(a)

According to the Inland Revenue Act No. 24 of 2017 (IRA) a non-resident person is liable to income
tax in Sri Lanka on income that arises in or is derived from a source in Sri Lanka. However,
generally, a double tax agreement (DTA) provides relief, wherein a non-resident will be liable to tax
in another state only if business is carried on through a permanent establishment (PE) in the other
state. Therefore, it is imperative to determine whether QBS Advisory Singapore has a PE in Sri
Lanka pursuant to the DTA between Sri Lanka and Singapore.

Per Article 5 of the DTA between Sri Lanka and Singapore, QBS Advisory Singapore would have a PE
in Sri Lanka in the following instances.

• Has a formal legal presence in Sri Lanka

Article 5 of the DTA between Sri Lanka and Singapore defines a PE to mean a fixed place of
business through which the business of an enterprise is wholly or partly carried on, and
specifically includes a branch, office or place of management. It is assumed that QBS Advisory
Singapore does not have a branch or office in Sri Lanka, through which its business is wholly
or partly carried out, given that QBS Bank Australia has established a separate subsidiary in
Sri Lanka to provide such services. Accordingly, there will be no PE exposure herein.

• Service PE

Even in the absence of a physical business presence, a PE could arise if there are personnel in
Sri Lanka providing services. According to paragraph 3(b) of Article 5 of the DTA, if services
are provided by an enterprise through employees or other personnel engaged by the
enterprise for such purpose for over 183 days (within any 12-month period), there would be
a PE in Sri Lanka. In the given context, the employees of QBS Advisory Advisory Singapore
were present only for 25 days during Y/A 2019/20 (12-month period). Therefore, since the
presence of employees in Sri Lanka within the 12-month period did not exceed 183 days, it
can be construed that QBS Singapore does not have a PE (service fee) pursuant to the above.

SL3 Suggested Solutions- March 2021 Page 2 of 20

 • Deemed PE resulting from a dependent agent

A PE will also arise if there is an agent acting in Sri Lanka, provided he habitually exercises an
authority to conclude contracts in the name of QBS Advisory Singapore.

The phrase ‘a person acting in a contracting state on behalf of an enterprise of the other
contracting state’ is not defined in the DTA. Per the OECD commentaries these persons need
not necessarily be employees of the company. The OECD commentaries goes on to state that
the phrase ‘authority to conclude contracts in the name of the enterprise’ is not confined to an
agent who enters into contracts literally in the name of the enterprise; this equally applies to
an agent who concludes contracts that are binding on the enterprise even if those contracts
are not actually in the name of the enterprise.

In the given case, QBS Advisory Singapore has appointed the General Manager for QBS
Advisory (SL). Although, legally, Rochell will be employed by QBS Advisory (SL), if she acts in
accordance with the instructions of QBS Advisory Singapore, she can be considered to be an
agent of QBS Advisory Singapore.

Rochell would enter into contracts in the name of QBS Advisory (SL). However, if these
contracts are entered into by her consequent to the services QBS Advisory Singapore
undertakes to perform pursuant to the agreement with QBS Advisory (SL), it can be
construed that Rochell is acting in Sri Lanka on behalf of QBS Advisory Singapore, and is
habitually exercising the authority to conclude contracts in the name of QBS Advisory
Singapore. The management fee which QBS Advisory Singapore receives is pursuant to the
obligations QBS Advisory Singapore carries out through Rochell.

If, however, it can be demonstrated that Rochell is independent of QBS Advisory Singapore
both legally and economically, this risk could be mitigated.

Based on the foregoing, there is a high PE exposure for QBS Advisory Singapore in Sri Lanka
and consequently it will be liable to income tax in Sri Lanka on the profit and income
attributable to the PE.
If, however, it can be established that there is no PE in Sri Lanka pursuant to the services
provided by Rochell, there will be no liability to income tax in Sri Lanka. Per the IRA, in order
to invoke any treaty benefit, at least 50% of the ultimate individuals who own QBS Advisory
Singapore should be residents of Singapore (unless QBS Advisory Singapore is listed in
Singapore). Failing which, there is a risk of denying treaty benefits.

(8 marks)

SL3 Suggested Solutions- March 2021 Page 3 of 20

(b)

Schedule of correct taxable income

Notes Rs. ‘000

Business income 1 938,070
Investment income -
Assessable income 938,070
Less: Qualifying payments 2 (1,500)
Taxable income 936,570

Note 1: Business income

Notes Rs. Rs.

Business income per original schedule 988,387,000
Add:
Fee on cross-charge (based on arm’s (i) 3,962,228
length)
Crop insurance levy (ii) 7,142,762
Accrued management bonuses to be paid (v) 7,000,000 18,104,990
on 1 June 2023
Less:
Debt repayment levy (ii) 40,837,933
Gratuity paid (iii) 2,318,476
Gratuity provision (iv) No
adjustment
No
Impairment adjustment adjustment
Provision per CBSL guidelines (vi) 9,442,140
Head office expenses (vii) 15,823,616 (68,422,165)
938,069,825

(i) In addition to the cost of recovery of the licenses, a fee would be charged from QBS Bank
(India) in line with the arm’s length principle, which has to be added to business income (→
44,569,489 * 8.89% = Rs. 3,962,228)

(ii) Per Section 10(1)(b)(x) of the IRA, taxes or other levies specified by the CGIR are not
deductible in arriving at the business income of the company. Pursuant to the above, Gazette
Notification No. 2064/ 54 dated 1 April 2018 specifies the taxes and other levies that are not
deductible in computing business income. VAT on FS, NBT on FS and crop insurance levy
(CIL) are included in this Gazette, and hence not deductible. Conversely, the debt repayment
levy (DRL) is not included in the Gazette and hence is deductible.

(iii) A retirement contribution is not deductible unless it is included in calculating the income of
the employee or is made to a fund that is approved by the CGIR, subject to any specified
conditions. Accordingly, the gratuity paid may be deducted. In the given case, since the
SL3 Suggested Solutions- March 2021 Page 4 of 20
 gratuity paid has been disallowed, even though not charged to the statement of
comprehensive income, twice that amount is deducted.

(iv) A provision for expenditure not yet incurred but expected to be incurred in a future year of
assessment is not allowable. Accordingly, the gratuity provision is not deductible.

(v) Management bonuses are not allowable as they will not be paid within 3 years from the end
of the year of assessment.

(vi) Per Section 66 of the IRA read together with Gazette Notification No. 2064/57 dated 1 April
2018, whilst the specific provision made for debt claims in accordance with CBSL guidelines
may be deducted, no deduction shall be allowed for a provision made in respect of the debt
claim given to an associated person (amongst others).

Accordingly, the CBSL provision deductible is as follows.

Rs.
Total provision 14,250,999
Provision for lease debtors (facilities granted prior to 1 April 2018) (3,539,187)
Provision in relation to QBS Advisory Singapore (1,269,672)
9,442,140

(vii) Per Section 79 of the IRA, head office expenses are deductible up to 10% of the assessable
income (subject to the DTA). Paragraph 3 of Article 7 of the DTA stipulates the conditions for
the deduction of head office expenses. Per the above, head office expenses shall be allowed in
accordance with the tax laws of Sri Lanka. Accordingly, the following expenses have been
excluded from the total head office expenses, since they do not come within the purview of
expenses that can be deducted under the IRA.

USD
Taxes (923,198 – 13,627) 909,571
Entertainment expenses 6,541,517
Depreciation 1,979,718

Therefore, the amount of the balance head office expense attributable to the Sri Lankan
branch amounts to USD 87,909 (Rs. 15,823,616).

This is allowable subject to 10% of the assessable income.

Rs.
Business income (before deducting HO expenses) 953,893,441
Assessable income 953,893,441
HO expense deductible (953,893,441 * 10/110) 86,717,586

Therefore, the entire head office expense of Rs. 15,823,616 is deductible since it is lower than
the above limit. Since this was not included in expenses, it is fully deducted.
SL3 Suggested Solutions- March 2021 Page 5 of 20
Note 2: Qualifying payments

Donations to approved charities are limited to Rs. 500,000. Rs. 75,000 is the limit for an individual.
Therefore, the donation to the Sevana Fund is fully deductible.
(9 marks)
(c)
Note Rs. Rs.
Corporation tax on taxable income @ Refer (b) above 936,570 262,240
28%
Remittance tax on remitted profits @ Refer note below 691,678 96,835
14%
1,628,248 359,075

Note: Remittance tax is computed on remitted profit, which is the accounting profit after income tax
in Sri Lanka. Since the head office expenses have not been accounted for in the draft financial
statements in arriving at the net profit before tax, such expenses are also deducted (Rs.
975,851,201 – Rs. 21,933,540 = Rs. 953,917,661).

Accordingly, the remitted profit is → Rs. 953,918 – Rs. 262,240 = Rs. 691,678
(3 marks)
(d)

(i) It is a fundamental principle of the code of ethics that advice to clients should be objective. A
firm’s ability to be objective may be threatened when there is a conflict of interest between
two clients. For example, the best advice for a group of companies may not be the most
advantageous for one or more directors. However, this need not be a problem, provided the
potential conflict is pointed out to all relevant parties and their consent is obtained to act for
them.
(2 marks)

(ii) If the firm is to act for the directors as well as the bank, it should consider introducing the
following safeguards.

• Have clear guidelines in relation to confidentiality

• Use separate teams for each client
(3 marks)
(Total: 25 marks)

SL3 Suggested Solutions- March 2021 Page 6 of 20

Answer 02

Learning outcome/s: 5.1, 5.3, 6.2 and 6.3

(a)

Wooden Works (Pvt) Ltd

VAT computation for the quarter 31 March 2020

Rs. ‘000 % Rs. ‘000

Output tax
Direct export sales 28,500 0% -
Indirect exports (SVAT sales) 195,800 8% 15,664
Local sales 87,500 8% 7,000
Local sales to customers not registered for VAT 2,200 8% 176
Sale of fixed assets 227 8% 18
Rent 120 8% 10
Total supplies 314,347
Total output tax 22,868

Rs. ‘000 Rs. ‘000

Input tax
Imports 540
Local purchases 1,520
SVAT purchases 11,440
Disallowable input tax (540)
Allowable input tax excluding b/f amount 1,520
B/f input tax 3,750
Total input tax 5,270
Allowable input tax
(A) Input tax related to zero-rated and
suspended supplies (1,520 * (28,500 +
195,800)/314,347) 1,085
(B) Not belonging to (A) (9 + 10 – 11) 4,185
Total allowable input tax 5,270 (5,270)
Tax payable 17,598
Deductions
Monthly payments (850)
Tax credit based on SVAT credit vouchers (15,664)

Balance tax payable 1,084

(10 marks)
SL3 Suggested Solutions- March 2021 Page 7 of 20
(b) Internal memorandum

To: Management of WWPL

The following penal provisions are applicable to RIPs and RISs per the Extraordinary Gazette
Notification No. 1986/9 dated 27 September 2016 (Clause 9 – Penal Provisions)

Registered Identified Purchasers (RIPs)

As the ultimate beneficiaries of the SVAT scheme, RIPs should strictly adhere to the SVAT
compliance and obligations, while supporting RISs to be compliant with statutory obligations.

• Not issuing due credit vouchers (by RIPs), or not submitting necessary forms by any RIP to
the CGIR on time, which in any manner affects the other party in the process, shall be strictly
dealt with under the statutory provisions of the VAT Act.

• After hearing the complaints from suppliers with regard to non-submission of credit
vouchers on time, if it is proved to the satisfaction of the CGIR that the negligence of such acts
has affected the suppliers, an assessment could be made on the respective RIP, or such RIPs
would be blacklisted.

• Not approving the respective Form SVAT 04 and not submitting Schedule SVAT 06 to the
CGIR by the RIP on time, which in any manner affects the other party in the process, will be
strictly dealt with under the statutory provisions of the VAT Act relating to the non-
furnishing of returns.

• If any goods or services exempted under PART II of the First Schedule of the VAT Act have
been purchased by any RIP under suspended terms, statutory provisions of the VAT Act will
be strictly applied.

Registered Identified Suppliers (RISs)

• If a suspended tax invoice has been issued in respect of goods or services that are exempted
under PART II of the First Schedule of the VAT Act, statutory provisions of the VAT Act will be
strictly applied.

• The negligence of suppliers in issuing suspended tax invoices, updating Form SVAT 04 and
Schedules SVAT 05, SVAT 05a, SVAT 05b and SVAT 07 to the CGIR on time, which in any
manner affects the other party in the process, will be strictly dealt with under the statutory
provisions of the VAT Act relating to the non-furnishing of returns.

(5 marks)

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(c) Tax minimising options

Investment of Rs. 240 million

There are no specific investment incentives given in the Inland Revenue Act No. 24 of 2017 other
than enhanced capital allowances given in the 2nd Schedule and the 6th Schedule.

WWPL is planning to invest approximately Rs. 240 million (~ USD 1.3 million). The investment of
USD 1.3 million is not entitled for enhanced capital allowances granted under the 2nd Schedule of
the IRA .

However, the 6th schedule of the IRA has granted ‘temporary’ concessions for investments in
depreciable assets amounting to less than USD 3 million, which is similar to the enhanced
depreciation allowance provided in the 2nd Schedule of the IRA. These are considered as temporary
concessions because the benefits are only available for 3 years from the date of implementation of
the new IRA (1 April 2018) (i.e. until 1 April 2021). Upon the expiration of this period, investment
incentives will only be given for investments above USD 3 million, provided that certain investment
criteria are met.

Investments up to USD 3 million will be entitled for an enhanced depreciation allowance of 100% of
the expenses incurred on depreciable assets in any part of Sri Lanka other than the Northern
Province, and 200% in the Northern Province.

The following criteria have to be met in order to claim enhanced capital allowances.

➢ The investment must be made on depreciable assets, which are classified as Class 1 or Class 4
assets under the terms of the IRA and depreciable assets (other than intangible assets)
comprising plant or machinery that are used to improve business processes or productivity
and fixed to the business premises.

➢ Class 1 and Class 4 assets are defined in the 4th Schedule as follows.

Class Depreciable assets

1 Computers and data handling equipment together with peripheral

devices.

4 Buildings, structures and similar works of a permanent nature

➢ Enhanced capital allowances will not be applicable if the investment is in relation to the
expansion of an existing business.

Enhanced capital allowances are available only for investments in depreciable assets made
after 1 April 2018.

Since the enhanced capital allowances referred to above are available only for a new business,
WWPL may consider incorporating a new company to obtain the facility. However, there is a
SL3 Suggested Solutions- March 2021 Page 9 of 20
negative point that such temporary enhanced capital allowances are only available for a period of 3
years from the date of implementation of the new IRA (1 April 2018) (i.e. until 1 April 2021).

Lower tax rate of 14%

The DIR has challenged the application of the lower tax rate of 14%.

Based on the information provided for Y/A 2018/19, the percentage of sales are as follows.

Rs. ‘000 %
Export sales 113,000 11.66
Indirect exports – SVAT sales to exporters 454,000 46.83
– SVAT sales to indirect exporters 268,400 27.69
Local sales 134,000 13.82
Total sales 969,400

Based on the above analysis, export sales are 58.49% (exports + SVAT sales to exporters).
Therefore, the predominant rule is not complied with. SVAT sales to indirect exporters are
considered as local sales as WWPL is the 3rd layer.

As given in the question, the percentage of sales are almost similar throughout the years. It is
recommended to continue and expand export sales and SVAT sales to exporters until the
percentage reaches 80%. This will enable WWPL to apply the lower tax rate of 14%.

Alternatively, WWPL can carry out production and local sales (SVAT sales to indirect exporters +
local sales) via a new company. The company performing local sales will be liable to income tax at
the standard rate (i.e. 28%).

However, it is advisable to consider other tax implications such as VAT on shared services and
transfer pricing, and also setting up and other administrative expenses such as audit fees, tax
service fees, fees payable to the Registrar of Companies etc. in this respect.

(10 marks)
(Total: 25 marks)

SL3 Suggested Solutions- March 2021 Page 10 of 20

 SECTION 2

Learning outcome/s: 1.1, 1.2, 1.3, 2.1, 4.3 and 4.2

Answer 03
(a)

Rs. ‘000 Rs. ‘000

Business income Schedule 1 2,248,568
Investment income Schedule 2 191,550
Total assessable income 2,440,118

Less: Qualifying payments and relief

Donation made to the University of Colombo (4,000)
CSR expenses: Planting of mango trees → Not allowed -

Taxable income 2,436,118

Income tax payable

Capital gains tax @ 10% 15,000 1,500
Balance taxable income @ 28% 2,421,118 677,913
2,436,118 679,413
Less: Tax credits
WHT paid Note 9 (8,073)
ESC paid (120,000)
Instalment payments made (450,000)
Capital gains tax Note 3 (1,500)
Income tax payable 99,840

SL3 Suggested Solutions- March 2021 Page 11 of 20

Schedule 1: Computation of business income

Notes Rs. ‘000

Net profit before taxation (per accounts) 2,489,126

Add:
Assessable charge/profit from disposal of fixed assets 4 6,000
Provision for gratuity 5 164,700
Write off of outdated drugs → Allowed -
Office maintenance (10% relates to power & energy) → Exempt
source → Disallowed 7,280
Staff welfare → Allowed as it is provided for all employees and
impracticable to ascertain the benefits to individuals -
Repairs and maintenance 6 1,335
Fines and penalties 360
Advertising and business promotion → Allowed since all
expenses are incurred in the production of income -
Depreciation and amortisation (accounting) 116,801
Brand launching expenses → Claimed against investment income 2 3,600
ISO certification charges → Allowed -
Anniversary expenses → Disallowed 2,000
CSR expenses 4,840
Loan interest incurred on foreign investments → Disallowed
(dividend income received from such investments is exempt) 2,900
Lease interest → Allowed -
Finance cost (term loan and debenture interest, bank overdraft)
→ Allowed 10 -
309,816
Less:
Rent income – Car park and pastry shop income → Effectively
connected to the business → No adjustment 1 -
Rent income from warehouse → Taxed as investment income 1 2,400
Royalty income → Taxed as investment income 2 2,700
Gain from disposal of private company shares → Taxed as
investment income 30,000
Dividend income (gross) 1,850
Cash award received → Effectively connected to the business →
No adjustments -
Profit from sale of fixed assets 8,100
Gratuity paid 5 51,857
Research and development → No additional deduction (just a
survey)→ Allowed -

SL3 Suggested Solutions- March 2021 Page 12 of 20

 Interest income from fixed deposits (gross) → Taxed as
investment income 91,250
Interest income from listed debentures → Taxed as investment
income 60,600
Staff loan interest 22,900
Change in fair value of financial asset at FVTPL 500
Change in fair value of investment property 42,117
Depreciation allowance 8 146,340
Exempt profit under Section 17A 89,760
550,374

Business income 2,248,568

Schedule 2: Computation of investment income

Rs. ‘000 Rs. ‘000

Dividend income → Exempt as HCL has more than 10% of the
share capital -
Rent income (Note 1) - 2,400
Royalty income (Note 2) 3,000
Less: Allowable expenditure (3,600)
Loss can be set off against investment income (600)
Interest income from fixed deposits (gross) 91,250
Interest income from debentures 60,600
Staff loan 22,900 174,750
Capital gain from share disposal (Note 3) 15,000
Investment income 191,550

Note 1: Rent income

Rs. ‘000
Rent income 25,300,000
Ground rent: Investment income (200,000 * 12) (2,400,000)
Car parking and pastry shop → Effectively connected 22,900,000

SL3 Suggested Solutions- March 2021 Page 13 of 20

Note 2: Royalty income

Rs. ‘000
Royalty income (net) 2,700,000
Add: Foreign tax credit @ 10% 300,000
Gross royalty 3,000,000
Less: Brand launching expenses claimed (3,600,000)
Loss (600,000)

Note 3: Gain from disposal of shares

Rs. ‘000
Accounting profit → Removed
Consideration received (1,000,000 * 40) 40,000
Less: Value as at 30 September 2017 (1,000,000 * 25) (25,000)
Capital gain 15,000

Note 4: Balancing allowance/assessable charge on disposal of fixed assets

Rs. ‘000
Motor car Not taxable
Land disposal (Rs. 10 million – Rs. 4 million) → Taxable 6,000

Note 5: Gratuity paid

Rs. ‘000
Opening balance as at 1 April 2019 235,652
Add: Provision for the year 164,700
Less: Actuarial loss (3,243)
Total 397,109
Closing balance as at 31 March 2020 345,252
Gratuity paid 51,857

SL3 Suggested Solutions- March 2021 Page 14 of 20

Note 6: Repairs and maintenance

Rs. ‘000 Rs. ‘000

Cost of repairs 1,900
WDV of building
Cost of building 11,900
Capital allowances claimed in Y/A 2018/19 (595)
WDV of building as at 31 March 2019 11,305
Deduction of the repair cost restricted to 5% of the WDV as
at 31 March 2019 565
Amount disallowed and added to the depreciation base 1,335

Note 7: Calculation of exempt profit under Section 17A of the Inland Revenue Act No. 10 of
2006 (per the transitional provision under the Inland Revenue Act No. 24 of 2017 such
exemption will continue)

Rs. ‘000
Net profit 89,760
Add: Accounting depreciation 3,000
Less: Capital allowances (Rs. 15 million * 10%) (1,500)
Exempt profit 91,260

Note 8: Depreciation allowance

Cost Years/% Amount

Rs. ‘000 Rs. ‘000
Depreciation allowance 2018/19 32,540
Depreciation allowance during the year
- Land → Not claimable 50,000 - -
- Medical equipment 340,000 5 68,000
- Intangible assets 84,000 10 8,400
- Motor lorry (leased) 5,000 5 1,000
- Motor cars for tourist transport 170,000 5 34,000
- Cutlery, crockery and linen (renew in 6 months) 2,400 100% 2,400
146,340

SL3 Suggested Solutions- March 2021 Page 15 of 20

Note 9: WHT paid at source

Rs. ‘000 % Rs. ‘000

Rent income 1,800 10% 180

Interest income from fixed deposits (gross) 91,250 5% 4,563
Interest income from listed debentures 60,600 5% 3,030
Foreign tax credit on royalty 3,000 10% 300
8,073

Note 10: Finance cost

Rs. ‘000
Term loan and debenture interest 422,595
Bank overdraft interest 192,500
615,095

Finance cost
Total borrowings 3,787,768
SC + reserves 12,731,028
Four times ‘SC + reserves’ 50,924,112
As four times ‘SC + reserves’ is much higher than the total
borrowings, the full interest cost is allowed for tax purposes

(30 marks)

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 (b)
Income tax implication arising from the transfer of assets by HCL

Per the provisions of the Inland Revenue Act No. 24 of 2017, a person who owns an asset is treated
as realising the asset:

• when the person who owns the asset parts with the ownership of the asset, including when it is
sold, exchanged, transferred, distributed, cancelled, redeemed, destroyed, lost, expired,
expropriated or surrendered.

Accordingly, when HCL transferred the depreciable/capital asset pertaining to the leisure & travel
and logistic sectors to the newly formed subsidiaries, it is considered as the realising of assets.

Items (c) and (d) of subsection (2) of Section 6 of the Inland Revenue Act No. 24 of 2017 state the
following.

(c) gains from the realisation of capital assets and liabilities of the business

(d) amounts required to be included by the Second or Fourth Schedule to this Act on the
realisation of the person’s depreciable assets of the business

form part of the business income.

Therefore, any gain or profit arising from the realisation of assets will form part of the business
income of HCL.

Per subsection (4) and (5) of Section 46 of the IRD Act:

where a person realises an asset, being trading stock, a depreciable asset, an investment asset or a
capital asset of a business, by way of transfer of ownership of the asset to an associate of the person,
and the requirements of subsection (5) are met:

(a) the person shall be treated as deriving an amount in respect of the realisation equal
to the net cost of the asset immediately before the realisation; and

(b) the associate shall be treated as incurring expenditure of the amount referred to in
paragraph (a) in acquiring the asset.

Accordingly, where a person realises an asset, being a trading stock, a depreciable asset and
investment or a capital asset of a business, by a way of transfer of the asset to an associate person,
he is deemed to derive an amount equal to the net cost of the asset immediately before the
realisation, if the following requirements are met.

• the person or the associate is an entity

• the asset or assets are trading stock, depreciable asset, investment asset or capital asset of a
business of the associate immediately after transfer by the person
• at the time of the transfer the person and the associate are residents
• there is continuity of the underlying ownership of the asset of at least fifty percent

SL3 Suggested Solutions- March 2021 Page 17 of 20

The net cost of an asset or liability at a particular time is equal to, in the case of a depreciable asset,
its share of the written down value.

As the newly formed companies are fully-owned subsidiaries of HCL, depreciable and capital assets
can be transferred at net cost. Accordingly, no gain/profit will arise from the realisation of assets.
Hence no income tax liability will arise to HCL.

VAT implication on the transfer of assets

Per the VAT Act, transfer of assets from HCL to the newly formed companies is a taxable activity
and accordingly VAT has to be charged on that taxable supply.

However, in terms of subsection (5) of Section 16 of the VAT Act No. 14 of 2002, transfer of assets
from one entity to another prior to the cancellation of the VAT registration could be excluded from
the liability to VAT, if the taxable activity (employing all such assets transferred) is carried on or
carried out continuously by the other person who is also a registered person .

Accordingly, there will be no VAT liability on the transfer of assets, as the newly formed companies
will continue to carry on the leisure & travel and logistics sector businesses provided the VAT
registration is obtained by the two new companies prior to the transfer of assets.

In any event, VAT will not be a cost to the group as input tax can be claimed by the two new
companies if they register for VAT prior to the transfer of assets.

Applicable income tax rate for new companies

Per the first schedule to the Inland Revenue Act No. 24 of 2017, as the newly formed companies are
fully-owned subsidiaries of HCL, they will not be entitled to the lower rate of 14% granted to SMEs
even if the turnover (of each newly formed company) is less than Rs. 500,000,000.

However, in the case of a company predominantly engaged in an undertaking for the promotion of
tourism, the applicable tax rate is 14%. Also, logistic services such as bonded warehouses or multi-
country consolidation in Sri Lanka is considered as a specified undertaking and the applicable tax
rate is 14%.

Accordingly, the 14% income tax rate can be applied for both the newly formed leisure & travel and
logistics companies if the required criteria are met.
(10 marks)

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(c)
(i) Per subsection (2) of Section 5 of the Inland Revenue Act No. 24 of 2017, gains and
profit from employment include:

(h) the fair market value of benefits received or derived by virtue of the employment by an
individual or an associate person of the individual
(i) other payments, including gifts received in respect of the employment

Accordingly, in order for it to be chargeable with income tax as profit from employment, the
benefit should be made due to the service of employment and there should be a nexus with
the employment contract.

HCL has carried out a free surgery for the employee’s mother not as a result of the
employment contract. The motive behind the benefit granted was to provide a social service
to a needy person.

Further in terms of Kanagasabapathy v Commissioner General of Inland Revenue, money

received under a health insurance scheme as reimbursement of medical expense incurred in
respect of the employer’s mother is not considered as part of profit from employment. It was
held that the essential point is that the payment was paid in respect of a personal situation
and it has a remote connection with his employment .

Hence the Assistant Commissioner’s opinion is incorrect and it should not be chargeable with
income tax in the hands of the employee.
(5 marks)
(ii) Per subsection (1) of Section 11 of the Inland Revenue Act No. 24 of 2017, in calculating a
person’s income from a business or investment for a year of assessment, expenses to the
extent they are incurred during the year by the person and in the production of income from
the business or investment, shall be deducted.

Also, in terms of subsection (2) of Section 11, expenses of a capital nature are not allowed.

Accordingly, in order to claim the expense as a deductible expense it must be incurred for the
purpose of earning profit or income, and it should be sufficiently connected to carrying on
any business/investment.
HCL is distinct from ESOP, and litigation expenses incurred against a claim of right by an
employee is not relevant to the business and it would not have an impact on the profit of HCL.
Further, per Commissioner General of Inland Revenue v A.W. Davith Appuhamy, the
respondent successfully repelled the claims of some associates to have a share in a business
called the Kandy Ice Co. and he claimed a deduction in respect of litigation expenses in the
computation of profit.
It was held that the litigation expense would not affect the profit of the business and it was
only relevant to respondent’s share, hence not deductible as an expense incurred in the
production of income.
Accordingly, the Assistant Commissioner’s opinion is correct and the litigation expense is not
deductible as it is not incurred in the production of income.
(5 marks)
(Total: 50 marks)

SL3 Suggested Solutions- March 2021 Page 19 of 20

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SL3 Suggested Solutions- March 2021 Page 20 of 20

SL3 Suggested Solutions March 2021