Understanding expenses to be deducted when calculating profit for tax purposes.
As we are approaching the due date for filing the return of income, it is vital to get a refresher on some of the taxation rules upon computing income for income tax purposes. In this article, we will focus on the general principles of deductions for purposes of calculating business income for tax purposes. The general rule is that all expenses incurred by a person wholly and exclusively in the production of business income can be deducted when calculating profit for tax purposes. Yet, there are exceptions to this rule where some expenses are non-deductible even though they were incurred by business. Expenses that are not allowed include consumption expenditure, expenditure of capital nature and excluded expenditure.
Consumption expenditure means expenses incurred by a person in the maintenance of themselves, their family or establishment, or for any other personal or domestic purpose. To illustrate, you are working as a human resource personnel and your office bought you a suit because you need to appear elegant and professional at work or when you attend meetings. Given your nature of work, you spend 21 days a month in the office since you rarely have office meetings outside the organization. As it appears, the suit is not utilized as much for office meetings, but for personal events such as weddings. The suit is most likely to be regarded as a consumption expenditure rather than an expenditure incurred wholly and exclusively in the production of income from the business. In contrast, when a Master of Ceremony (MC) buys a suit, the cost may not be regarded as consumption expenditure because a professional and elegant appearance for an MC is directly linked to their business income.
Expenditure of capital nature
These are expenses used to purchase an item of which the benefit will last longer than 12 months (also known as capital goods/ items or assets). Capital goods could either be tangible or intangible such as computer software, lease of buildings. Expenditure of capital nature is not allowed for deduction upon computation of profit for tax purposes. Nonetheless, the Income Tax Act, 2004 (ITA) provides basis for computing deductible capital allowance for qualifying capital goods upon computing profit for tax purposes.
For illustration purposes, we will assume that an office computer was bought for TZS 3,000,000 in 2021. Since the computer is made to last for more than 12 months, it qualifies as a capital good hence its cost cannot be deducted when computing profit for tax purposes. However, for qualifying capital goods ITA allows deductions in the form of “capital allowance” whereby for computers, the deduction of the cost will be at 37.5% every year, on a reducing balance method. In relation to the value of TZS 3,000,000, the cost will be split over several years, thus enabling the purchasing company to deduct the cost of the computer as a capital allowance.
This category is more general and enlists all other expenditures that are not allowed for deduction upon computation of profit for tax purposes. It includes taxes payable under the ITA; bribes and expenditure incurred in corrupt practices; fines and penalties payable to a government or a division of the government; expenses relating to incomes that are not subject to business taxation; dividend paid and withholding taxes paid on behalf of the payee.
One of the most interesting items is expenditure incurred in corrupt practices whereby parties involved may not be aware of the tax implication. A common example is when a supplier or vendor pays a fee to a company to ease winning of a tender. One would want to justify the transaction to be wholly and exclusively for purposes of obtaining a tender out of which, income is generated, and profit is available for taxation. In other words, if the facilitation fee is not paid perhaps there would not be income to charge tax. However, if the transaction is not done with openness, such expenses shall not be deducted when calculating profit for tax purposes. Accordingly, upon computing profits of the business, such expenses will not be considered for deduction hence leaving the profit base for tax purposes on the high end.
Therefore, to avoid future tax liabilities, it is imperative for taxpayers to only deduct expenditure that is incurred wholly and exclusively in generating business income as explained above. Failure to do so will result to underpayment of taxes hence a possible imposition of penalties and interests enforced by the taxman.