Taxation in Real Estate 13: Income Measurement and

Income Measurement and
Taxation in Real Estate 13
Chapter objectives:
Nature of business
Revenue
Cost of sale Inventories
Investments
IAS and BAS I l : constftlction contracts
Borrowing costs
Maximize capital gain
Low-income housing tax credit
Real estate business, particularly consfruction of buildings and bridges

usually take more than one year and therefore income and expenditure of
a project may spread beyond one year. In such cases revenue and
expenses are allocated among more than one year. Whereas in case of
products these are completed in one year and actual revenue and
expenses are clearly identified with that year and therefore yearly profit
or loss determination is easier. But in real estate yearly completion state
has to be estimated and accordingly revenue and expenses are allocated
to that year. Estimates of project income and project costs are reviewed
periodically. The effect of changes to estimates is recognized in the
financial statements of the period in which such changes are determined.
Thus in real estate profit or loss determination is more an estimate
compared to other products and services.
Taxation
172
Nature of the business

Real estate industry makes allotment of the plots and apartments
ahead of commencement of land reclamations, development and
construction of apartments. The companies receive money against
such allotments on installments basis during the span of two to six
years. The amount is booked under 'advance on allotment' as current
Scanned with CamScanner

Income Measurement and Taxation in Real Estate 172
liability. Revenue is recognized by reference to the stage of
completion of the project at the end of the accounting period.
Inventories
Inventories represent stock of land, apartments, shops and office spaces.
These can be underdeveloped land, work-in-process, developed
inventory and construction materials. These are valued at lower of cost
and market as per accounting standard. Cost is measured usually at
average cost.
Revenue
Revenue is recognized as per IAS 18 which says that revenue is
recognized until economic benefits will flow to the business entities and
are reliably measured. It is measured project by project and then added
to arrive at the total revenue of a particular year. Revenue associated
with apartment sale shall be recognized by reference to the stage of
completion of the apartment at the end of the reporting period.
Cost of sale
Cost of an apartment project includes all costs to bring the asset to a
working condition or intended use. Costs of dismantling and removing
items in the previous condition are also included in the costs of the new
property. Borrowing costs directly attributable to construction or
production of an asset that necessarily takes a substantial period are
capitalized and allocated as expense in various years under
construction. Other borrowing costs which are not directly related to a
project are expensed in the period they occur. Cost of sale of Eastern
Housing Limited is
Opening stock of underdeveloped land xxx
Add purchase of underdeveloped land XXX
Less stock of underdeveloped land XXX
Consumption of land during the period

Opening stock of construction materials
Add development and construction materials XXX
Materials consumption during the year

Add direct expenses XXX

Total cost transferred to work in process (W-I-P) XXX
Add opening W-I-P XXX
Less closing W-I-P

Cost of finished inventory
Add opening finished inventory
Less closing finished inventory
Cost of sale
IAS and BAS 11. Construction Contracts
Profit is measured by estimating costs and revenue by percentage of
completion basis, that is, accrual basis. In case of estimated loss, it is
immediately recognized in the current year rather than allocating its costs
and expenses over the period of construction.
An example
Profit by percentage completion method, 2017
Estimated costs to complete TK825000
Actual costs to date 275000
Total estimated costs 1100000
Percentage complete in 2017 (275000/1100000)
Total contract price 1500000
Estimated gross profit
400000
Profit to date 25%
100000
Income tax expense @25%
25000
T
74 axation
List of Projects with Completion Stage and Revenue

The completion stage of each project is estimated like Project I:
80%. complete, Project 2: 60% complete, Project 3: 25% Complete,
and Project 4: 0.03% complete. Then revenue is recognized project

wise as per stage of completion. The total of the revenue of all
projects together is shown in the income statement.
Before IAS 11
Before IAS Il, profit in real estate business was determined by the
above accrual basis or by cash basis, that is, there was discretion
Under cash basis, revenue was recognized when the project was
complete. So accrual accounting was not followed during the period
from beginning until the end completion of projects. Cash basis
however does not show the real performance of a project in the
intermediate periods.
Use of Estimates and Judgments

The preparation of financial statements require management to make
judgment, estimates and assumptions that affect the application of
accounting policies and the reported amounts of its assets, liabilities,
income and expenses and disclosure of the contingent assets and
liabilities at the date of the financial statements. Actual results may
differ from those estimates. Estimates and underlying assumptions
are reviewed on an ongoing basis. Revisions to accounting estimates
are recognized in the period in which the estimates are revised and
in any future periods affected.
Measurement and Recognition

An item of property, plant and equipment qualifying for
recognition is
Initially measured at its cost. Cost comprises expenditure that is
directly attributable to the acquisition of the assets. The cost of
selfconstructed asset includes the following: the cost of materials and
direct labor; any other costs directly attributable to bringing the assets to
a working condition for their intended use; and when the company has
an obligation to remove the asset or restore the site, an estimate of the

costs of dismantling and removing the items and restoring the site on
which they are located.
Borrowing Costs
Borrowings are classified into both current and non-current liabilities. In
compliance with the requirements of IAS/BAS - 23 "Borrowing Costs,"
borrowing costs directly attributable to the acquisition, construction or
production of an asset that necessarily takes a substantial period of time
to get ready for its intended use or sale are capitalized (transferred to the
construction work-in-progress) as part of the cost of the respective assets.
All other borrowing costs are expensed in the period they occur.
Borrowing costs consist of interest and other costs that an entity incurs in
connection with the borrowing of ftlnds.
Income tax
Income tax comprises both current tax and deferred tax expense.
Current tax
As per section 53FF of the Income Tax Ordinance (ITO) 1984, it is

made compulsory for the real estate business entities to pay, irrespective
of profit or loss, income tax as per prescribed rate per square meter of
the apartments at the time of their registration under
section 82C of ITO 1984. Provision for income tax has been made at
prevailing corporate tax rate @ 25% besides income taxed under the
above sections as per provision of the ITO 1984. Current tax is the
Taxation 176
expected tax payable or receivable on the taxable income or loss for the
year, using the tax rates enacted at the reporting date and any adjustment
to tax payable in respect of previous years.

Deferred tax
Deferred tax is recognized in compliance with BAS - 12 "Income Taxes",

providing for temporary differences between the carrying amounts of assets
and liabilities for financial reporting purposes and amounts used for taxation
purposes. Deferred tax is measured at the tax rates that are expected to be
applied to the temporary differences when they reverse, based on the laws that
have been enacted or substantively enacted by the date of statement of
financial position. Deferred tax assets and liabilities are offset if there is a
legally enforceable right to offset current tax liabilities and assets, and they
relate to income taxes levied by the same tax authority on the same taxable
entity. A deferred tax asset is recognized to the extent that it is probable that
future taxable profits will be available against which the deductible
temporary difference can be utilized. Deferred tax assets are reviewed at
each date of statement of financial position and are reduced to the extent
that it is no longer probable that the related tax benefit will be realized.
Disclosure
Tax related information is shown in three financial statements,
deferred tax as a current asset, provision for income tax as current
liability, tax expense in income statement, and income tax paid in cash
flow statement. Further information is shown in notes.
Eastern Housing Ltd. Balance Sheet, 2016
Assets
Curent assets:
Deferred tax TK4.3 million Equity and Liabilities
Current liabilities :
Provision for income tax 16.9 million

Income Statement, 2016 Expenses:
Income tax expense

Current tax TKI 18.8 million
Deferred 1.3 Total 120.1
Cash flow from operating activities:

Income tax paid TK 108 million
Notes
Note 33
Tax paid at the time of sale of registration (advance income tax)
TK90.2 million
Tax paid for purchase of land
Tax deducted at source (TDS) 0.4
Provision for Income tax 28.2
Total charges in the income statement 118.8
Note 6
Deferred tax
Book Tax base Difference
Provision for gratuity TK25 m TK25 m
Fixed assets (4662) (4649) (13)
Provision for warranty 4.5 4.5
Total difference
17
Tax rate
Deferred tax liability (asset) Provision for income tax:
Taxation
TK9.2
118.8
128
108
20

(deferred tax TK4.2 adjusted, so the balance is higher than 16.9 in
Balance Sheet)
Maximize Capital Gains

Capital gain tax is 15% whereas corporate tax is 25% for a PLC, 35% for
a private company, and 0 to 30% for a partnership firm. So a real estate
business will try to get maximum benefit of lower capital gain tax. The
sale of land that is held for investment purposes will qualify for long-
term capital gains treatment if the land has been held for more than one
year prior to the sale, whereas the sale of land that is held as inventory by
the seller will be subject to tax at the higher ordinary income tax rates. A
parcel of real estate that is purchased as an investment and held for more
than one year, without improvement, will qualify for long-term capital
gains treatment, whereas a large number of lots that are sold by a
development entity that has consfiucted major improvements in a
subdivision will be considered inventory with the sales subject to tax at
the higher ordinary income tax rates.
Low-income housing tax credits

In order to encourage developers to build, manage and maintain
affordable rental housing for lower income persons, The USA Federal
tax credit is generally 9% per year of the eligible cost of the buildings
each year for a 10-year period, i.e. a total Federal tax credit equal to
90% of the eligible cost of the buildings. The occupants must have
income below certain maximum levels, and rent is restricted based on
the occupants' income. Because of limitations on the ability of
individuals to utilize the Federal credit, the primary investors in these
projects are typically large companies (frequently banks, because of the
added incentive of getting credit under the Community Reinvestment
Act). The state credit, which does not necessarily have to be allocated to
the same investor as the Federal credit, is often allocated to individuals
or insurance companies.
Question
1. How is real estate business accounting different from the
accounting of a manufacturing business?
2. How is profit determined in a real estate business?

3. How is cost of sale determined in a real estate business?
4. What is special about tax planning for a real estate company?
Exercise
I.XYZ Housing Ltd has the following assets in the balance sheet
Investment in land at cost TKIOOO million'
Inventory of completed projects: 2500 sft flats TK200m 600 sft
flats 400m
Both the products are sold at 13% profit on cost
How can the company get maximum tax benefits? Assume that tax laws
(i) will introduce tax credit of 5% for low-income housing projects, and
(ii) will allow capital gain tax instead of corporate tax rate for
investments.

Income Measurement and

Taxation in Life Insurance Business 11
Chapter objectives:
Regulation
The Fourth Schedule
Actuarial valuation
Surplus and deficit
Profitability
Flaws in taxation and government revenue
Audit report
DRA
FRS 4
Introduction
A public limited company cannot exist without a profit and
loss account in its annual report, But our life insurance
companies do not prepare a profit and loss account in their
annual report. Not only public limited companies, any form of
business organization, without a profit and loss account is
unacceptable. All business organizations must prepare a profit
and loss account every year to determine their profit and pay
tax on such profit after some adjustments by the tax authority.
An
d what is yearly profit and loss of a business and how it is
determined is well settled by domestic and international
accounting standards.
Our life insurance companies prepare a revenue account but not a

profit and loss account. They determine a long term surplus (not
yearly
Taxation

profit) by taking the difference between the closing balance of
revenue account and estimated yearend insurance liabilities of
claims of policies maturing after the balance sheet period but
may be falling during the balance sheet period. And they provide
corporate tax on this surplus. These practices are inconsistent
with the global accounting and taxation standards and practices.
Neither profit nor actuary valuation of insurance liabilities of
those policies is disclosed anywhere in the financial statements.
The most vital information-profit or loss of the business is
nowhere available in the financial statements which the
stakeholders frequently use for decision making. As a result,
stakeholders do not know the profit or loss figure and
consequently cannot verify the corporate tax charged in the
revenue account. Accounting principles require that all revenues,
expenses, assets and liabilities must be disclosed in the financial
statements such as income statement and balance sheet.
Insurance liability is a valuation account and a continuous
account carrying a beginning balance, movements during the
current year and an ending balance which must be disclosed in
the balance sheet. But this liability amount which is used by our
companies for determining the surplus for tax purpose lies
outside the financial statements, and so there is likely a higher
motivation for the company, their actuaries and accountants for
over valuation of this liability and consequent underpayment of
corporation tax.
This article therefore, reviews the taxation regulations related

to life insurance business, shows and explains why the existing
accounting in our life insurance companies is faulty, shows and
explains the standard accounting practice in life insurance
companies around the world, tests the hypothesis that our companies
suppress profit figures and avoid corporate tax, shows that the audit
reports are faulty, critically explains the relevant role of the
Insurance Development Regulatory Authority, and finally gives a
conclusion.
The regulation
Our Income Tax Ordinance 1984 (section 2(a) and the Fourth

Schedule) requires corporate tax to be determined by the higher
of the
volt10tion, External Citt'ltinp,N noncore il)icjct't,
items cannot be the measure ol' (prolif or lout') 01 mail) activities ol' Il
business which liltH Corc
financing and investing activities but lift.' claims are principally

operating activities, Again, cxlcl'l)tll such as interest, dividends
and rents cannot bc management expenses because the Iti(tcr
rcltt(e predominantly for operating activities such as policies,
their premium (tild claims and benefits. This method thus could
not stitislÿ 'matching principle' of accounting. It also violates
the filli(lamenttll accounting concepts viz., 'periodicity concept'
and 'accrual concept' because till rcvcnucs and expenses during
a period arc not taken in that period rather only a part of those
have been considered. Importantly, (his docs not measurc true
yearly performance ol' the business on which resource allocation
such as claims and bonuses to policyholders, dividend to
shareholders, corporate income tax and employee bonus are
based.
Nearly all companies always showed losses by this method and

the government did not get any tax. For example, Metli(Z'
Bangladesh during 2012-13 reported an external earnings of
million and allowable management expenses of TK4067 million
resulting a loss of TK532 million. Popular Life Insurance
Company reported a loss of TK124m in 2014. This loss scenario
is truc for all other companies for all time from beginning to
today except Delta Life Insurance and Jiban Bima corporation
who used this method in the recent years. In 2014 Delta's
external earnings were TK3034 million, allowable management
expenses were TK 1535m and a gain of TIC 1499m. Even
Delta's admissible management expenses were higher than
external earnings before 2008. Overall, this method was not
used for determination of profit and corporate income tax in our
life insurance companies.

Taxation
The second method

The second method of measuring profit or loss involves two
disciplines of knowledge: accounting and actuary science. This
second method is an internationally accepted standard for
determining profit or loss in life insurance business. Our life
insurance companies also apply actuary science in determining
surplus or deficit but they call it profit or loss which is faulty.
Their actuarial surplus or deficit on the balance sheet date is
followed from the British Life Assurance Companies Act 1870
which equal to year-end balance of revenue account minus year-
end liabilities due to all policics plus premium to be received
from thesc policies. But this surplus is a measure of long term
solvency of the firm on the balance sheet date not the measure of
annual profit for the accounting year. The problem of
considering this long-term surplus as annual profit is that both
the year-end balances are accumulated from the past and as a
result the surplus is not the current year's result. Thus tax
calculated on this surplus will not be tax on current year's result
(profit). That is why the 1870 Act did not give provision for
income tax in their revenue account. It should be mentioned here
that actuarial valuation of ending liabilities may be correct but
the surplus under this method and calling it profit and
corresponding tax provision on that are faulty. This surplus is not
the profit of the current year rather it is the surplus representing
the solvency of the business on the balance sheet date. This
method of determining surplus involves past (beginning balance
of revenue account), present (current year's premium and other
incomes, and claims paid and intimated of policies maturing on
the balance sheet date) and future (ending balance of liabilities to
all insurance policies maturing on the balance sheet date and
beyond). It should be noticed here is that the last item—ending
balance of insurance liabilities counts 'policies maturing on the
balance sheet date' twice. Thus the existing method of surplus
determination suffers from two problems: accumulated balance
(past) and double counting of liabilities to policies maturing on
the balance sheet date. Thus their surplus valuation and
corresponding tax determination violates the accounting

Inconte Measurement and Taxation in Insurance Business 184
Life
principle of periodicity, This accounting principle is an accounting

findamental well accepted throughout the world for all business
organizati011S. Under this principle, performance of a business
measured by profit is related to a particular period of time usually one
year. This method also violates another basic accounting principle of
matching where current period's all revenues are matched with current
period's all expenses.
Our life insurance companies claim that they determine the above
surplus or profit according to the Fourth Schedule of the Income Tax
Ordinance 1984. But the law did not suggest the above method at all. It
says, "The profits and gains of life insurance business, other than
pension and annuity business, shall be the annual average of the surplus
arrived at by adjusting the surplus or deficit disclosed by actuarial
valuation made for the last inter-valuation period ending before the year
for which the assessment is to be made, so as to exclude from it any
surplus or deficit included therein which was made in any earlier inter-
valuation period, and any expenditure other than expenditure which
may, under provisions of section 29 of this Ordinance, be allowed for, in
computing the profits and gains of a business." In 1938 Insurance Act,
there was provision for actuarial valuation at least once in three years.
This provision is not acceptable because it allows determination of
profit or loss once in three years. That is why new Insurance Act 2010
requires valuation every year. So the question of 'average' does not
arise. Importantly, this provision of the law rightly requires the actuarial
valuation of insurance liabilities which is the international practice for
determining insurance liabilities. This provision does not say anything
about how profit and loss will be determined because determination of
profit and loss is a well-settled issue which is the jurisdiction of
accounting discipline not that of taxation. The Actuarial Report u/s 13
requires the long-term financial condition (surplus) be determined by
the Fourth Schedule, part I and Part ii. The 2010 Act repealed these
requirements by section 30. The Indian Insurance (Amendment Act
2015 also omitted the Fourth Schedule of the Insurance Act 1938.
T

Further flaws in their surplus or deficit
Our Actuaries compare revenue balance against potential
insurance liabilities of all policies falling due in the accounting
year (policies maturing on the balance sheet date and beyond).
Revenue account takes into account all revenues and expenses
(except depreciation) which are actual figures and thus the surplus
in this account is an actual figure. But the said liability
(particularly of policies beyond accounting period) all came
through estimates based on various imperfect assumptions of
actuarial valuation. All actual performance cannot be set off
against the said all predicted and estimated performance. A frue
surplus or profit is the difference between actual and estimated
revenues and expenses during a particular period of time. Since
the actuarial liability is not incurred in full, in essence, the
revenue fund balance is the propriety of the owners but at the cost
of the government because income tax is provided after this
liability. As a result, every year, owners' equity (including
revenue account fund) accumulates to an amount which is 4.5
times to 13.8 times of liabilities (claims paid in cash flow
statement) to policyholders. But in banks, the figure ranges from
0.07 to 0.10 times (Appendix 5). Further, 90% of the surplus is
allocated for policyholders and 75% of this allocation is tax
deductible. This regulation u/s 49(A) of the 1938 Act and also of
the Insurance Corporation Act 1973 further increases the revenue
for the benefit of the owners but at the cost of government
revenue.
The relevant literature, IFRS and World experience

The UK and USA life insurance businesses (Legal and General, Royal
London, Metlife, Foresters) prepare a standard income statement
(profit and loss account) not revenue account, determine their yearly
performance and tax on that performance or profit. An income
statement takes into account all revenues including premiums received
and due, external earnings like interest, dividends and rents, expenses
including insurance claims and benefits paid and intimated, and
management expenses such as agents' commission and allowances and

administrative expenses and depreciation. To these, one more

item is added: the potential claims and benefits of policies
maturing beyond
LiJè
the curent year but may fall due in the current year. This item of
expense in UK, USA and India is called changes (movement) in
policyholders' liability which is the difference between ending and
beginning liabilities to policyholders. It has to be mentioned with
emphasis that this difference or change between ending and beginning
is the claims expenses relevant for the current year. And the difference
which is charged in the income statement can be verified by
comparing two years' insurance liability account and their balances in
the balance sheet. For example, ICICI has charged insurance claim
increase of Rs.101550 in 2011 income statement which is the
difference between insurance liabilities balances in the balance sheet,
Rs.641204 in 2011 and Rss 539654 in 2010. The liability estimation
for death benefits uses actuarial science where for each policyholder
probability of dying is taken from the mortality table. Estimates for
other claims and benefits by maturity, surrender and survival use
various assumptions for probability, interest, inflation, expenses, target
profit, market competition and other contingencies (Fourth Schedule,
Insurance Act 1938). Indian companies like LIC and ICICI prepare a
revenue account (also called policyholders' account and technical
account) and a profit and loss account (also called shareholders'
account and nontechnical account). Revenue account deals with
insurance related business revenues and expenses and profit loss
accounts deals with incomes (gains on sale of investments) and
expenses not directly related to insurance businesses such as bad
debts. In essence, these two accounts are the split of the profit and loss
account because revenue account shows the operating revenues like
premiums and operating expenses like claims and the balance is
transferred to the profit and loss account.
Life insurance companies around the world except Bangladesh

follow basic accounting principles and practices in measuring profit
or loss for a particular period, British, American and Chinese
companies prepare an income statement. Asian countries like India,
Pakistan and Nepal prepare a revenue account and an income

statement. Revenue account finds the profit or loss from life
insurance related activities, and income statement finds profit or loss
from non insurance related

132
activities. If corporation tax rate is a flat one, keeping of two accounts

should not create any problem. But where corporation tax rates are
progressive, for example, UK's corporate income tax rate is 20% for
profit up to £300000 and 21% for profit above £300000 and thus UK
companies prepare an income statement taking both insurance related
and noninsurance related revenues and expenses. It appears that separate
revenue and income statement does not serve much purpose. It also
makes accounts complicated. If insurance regulations particularly
relating to allocation of profit to policyholders and shareholders are
competitive and transparent then the separation appears to be not that
worthy. The distributable profit as dividend must depend on directors'
discretion, advice of the actuary who must have regard to any excess of
assets over liabilities, the required solvency and the need to provide
against adverse future developments.
IFRS 4, accounting for life insurance prescribes the same international

structure of profit and loss account and balance sheet for life insurance
companies. There is no requirement for a revenue account. For life
insurance business it requires an insurance liability account which has a
carrying amount through a Liability Adequacy Test (LAT). Any
deficiency in the account is recognized in the profit and loss account. The
annual basis of accounting presently used worldwide for life insurance
business measures profit or loss more 'realistically' and are more
comparable to the accounting conventions of non-financial companies
(Horton and Macve 1995). Only our life insurance companies still follow
the solvency approach of surplus determination which was established by
The 1870 Life Assurance Companies Act (Horton and Macve 1996) of
Britain. The surplus or deficiency according to the 1870 Act (5th
Schedule) is the measure of solvency or insolvency of the companies on
the balance sheet date, but is not the measure of profit or loss for an
accounting year. Importantly, there is no item of corporate income tax in
the revenue account under this Act. King (1892: 504) suggested
amendment to the 1870 Act to include a profit and loss account to its
existing accounts. There is no trace of such accounting in any life
insurance company in any other counffy around the world as per annual
reports available in the Internet. ICICI Life

an Indian company follows the standard accounting practice and
prepares a profit and loss account since 2001. The Act's Fifth
schedule measures surplus or deficiency as the difference between
revenUe ñlnd and actuarial liabilities on the balance sheet date. The
balance indicates the solvency or financial position of the business.
That is, how far the frnd and its corresponding assets are sufficient to
meet liabilities to the policyholders. For solvency measurement this
method can be used but this is not acceptable for measurement of
annual profit and tax thereon. Solvency measures long-term health but
profit is annual performance of the business which is required by
basic accounting and taxation principles. The Insurance Laws
(Amendment Bills 2015) of India u/s 18 and our Insurance Act 1938
u/s 13 (proviso 4) requires solvency report to be sent to Insurance
Regulatory Development Authority (IRDA) and DRA respectively
once in every three years but for profit determination, actuary
valuation of liabilities must be done once in every year. This
provision indicates that solvency report is not used for determining
profit and tax which must be determined every year.
Methodology
The relevant literature above suggests that our life insurance
companies apply faulty accounting in our life insurance companies. I
hypothesize that these companies understate their profit and
corporate tax. To test these I compare profitability and corporate tax
charges of our companies with those of foreign companies.
The study is based on secondary data from annual reports available

through the Internet. There are currently twenty four Dhaka Stock
Exchange listed life insurance companies but sixteen companies have
been incorporated in 2013 and their annual reports are not available
Yet in the Internet. I found nine companies where relevant data are
available. To compare our companies with foreign companies I
wanted to take as many companies as possible but the relevant data
are not available and also there are time and space constraints. I
found six companies from India, three companies from UK, two
companies from 134

Inconte Measurement and Taxation in Insurance Business
190
USA, one company from Canada, and one company from China where
relevant data are available.
The period of study is 2013-14, the most recent period where data arc
available, The work also attempted to study two years before 2010
when new regulation, the Insurance Act 2010 has come into place
(previously it was Insurance Act 1938) in order to see if there is any
difference between the pre and post regulation period. But Annual
reports of many companies before 2010 are not available in the
Internet; when available, tax provision is not available. For example,
Delta, the largest life insurance business in Bangladesh did not provide
for income tax in its revenue account. Before 2010, surplus or deficit
through actuarial valuation was done once in three years (at least once
in three years was the regulation). So income tax provision for each
year was not possible. Delta's notes to financial statements therefore
mentioned that income tax was deducted at source.
I determined profitability by dividing profit before tax by total revenue.

I also determined corporate tax-revenue ratio by dividing corporate tax
by total revenue. The average of two years' (2013 and 2014) data is
taken into consideration. Also, abnormal years where there were not
profits but losses were ignored. The hypothesis is that profit is
understated because of the flaws in the income (surplus) measurement
method used by our life insurance companies. This hypothesis can be
contested however, because profitability may be lower for competition
in the industry. But it does not appear to be so because sixteen
companies have been incorporated in the year 2013 alone, and several
others have applied to the government for registration. And before 2010,
only five or six companies monopolized the market.
The unit of study—profit is not available in the financial statements

because the companies do not prepare a profit and loss account. I
struggled to find out a profit figure because I cannot believe a business
organization particularly a public limited company can exist without a
profit and loss account in its annual report. I then found a method to
arrive at this figure. The companies disclose the current income tax

Income Measurement and Taxation Insurance
tn Life
provision in the revenue account and I divtdcd this current tax provision by
0.425, the corporate tax tate for life tttsurance companies.
profit before tax 'A current income tax pro" ision 0.425
This current tax is the tax
need exclustvcly for ch'trgcd

companies and forctgn companies,
Profitabilits
Our life insurance companies, for profit
the accounting
fundamentals like also neithcr
pcrtodtctty concept account
properly, 'They los
me.i'ure
regarding profit
and calculate a
surplus 'Allich is
British Act v,hich is no more determtnatton Of profit.
accounting de g.oid of the rot of thc ptofit can be suppressed and
corporate tax :notded. To test this h',pothcsts I calculated a standard
profitabiltty ROS ot return on here for life insurance business.
ROR or on total I took an profit before tax as a of total for
2013 to 2014 (Appendžxl) and did the T•test and aralysis in Table l.
Slean profitability in Bangladeshi is 247% and tn foreign
countries is 6.12% and they are significantly different. The results
indicate that Bangladeshi companies' repotted profitabiltty is much Iou

Inconte and in Incurancc Business 192
er than that of foreign companies. But the results will have to bc taken
with care because some Bangladeshi companies for example, 136
Sandhani, National and Meghna's profitability is higher than that of

some foreign companies (Appendix 1). It means that all Bangladeshi
companies do not underreport their profit and profitability.
Table 1, Profitability
Variance Standard
Deviation
Mean
Counfry
2.478667
6.122174 2.057098 1.434259 57.864
Bangladesh
14.652445 3.827851 62.5244
Rest ofthe
World
t- Test for Equality of Population Means between Bangladesh and
Country t-Test Probability

Bangladesh 0.00025891
Rest of the World
Rest
ofthe World
F-Test for Equality of Population Variances (Upper Tailed Test)

Country F-Test Prob
Rest World 7.12287* 0.00023152
Bangladesh
Flaws in taxation and loss in Government Revenue
The above paragraphs showed that there are flaws in income
measurement in our life insurance companies. Since there are flaws
in income so there are flaws in tax as tax is based on income. I
expected that tax as a percentage of total revenue would be lower in
our companies compared to foreig'l companies. But comparing this
variable across countries is faulty because corporate tax rates across
,lfcíð5toet'tcnt rttxatíon
countncs arc largely different. It is 42.5% in Bangladesh for life

insurance companies, 21% in UK, 39% in USA, 34.6% in India, 25% in
China, 26.50/6 in Canada, 23.9% average in Asia and 22.6% global
Table 2 shows that even corporate tax rate in Bangladesh is
almost double the Asian and global average, the experimental variable,
that is, tax as a percentage of total revenue is lower in Bangladeshi firms
compared to foreign firms. It is however not significantly different.
Also, like profitability in Table l, Sandhani National, and Meghna's
income tax payment is higher than that of some foreign companies.
Why is 90% of actuarial surplus a tax deductible expense? Is it not a

subsidy? Is that subsidy justifiable for decades? Importantly, there is
already actuarial valuation of insurance liability including bonus to
policyholders (Fourth Schedule, part 2, 2(d) and deducted from the
insurance fund to arrive at actuarial surplus. For financial accounting
purpose and long-term growth and solvency of the business, the
Insurance Act 1938 (49A) suggested 90% of the surplus to be
allocated for the policyholders and this allocation is based on
longterm solvency (yearend insurance fund less yearend insurance
liabilities) of the business not based on yearly profit of the
companies. This provision has been deleted in the new 2010 Act (u/s
82) which allows a maximum dividend of 10% to the shareholders.
Section 83 says allocation of surplus for policyholders shall be
according to the rules of the Act. All reserves and provisions may be
good for financial accounting purpose but are not admissible
deductions by corporate income tax laws (Sections 29 and 30 of the
Income Tax Act 1984). The Act (Fourth Schedule) u/s 4 allows 75%

of 90% allocation to policyholders as an admissible deduction but the
proviso says if the money is not paid to the policyholders, the entire
allocation may be considered income. Appendix 5 shows that the
allocation was not spent for the policyholders and as such huge
amount accumulated to the equity including revenue fund which was
4 to 13 times of cash paid to policyholders, It should be mentioned
here that in other business sectors, bad-debts are allowed as a
deductible expense but provision for doubtful debts is not. For
financial institutions however,

Advanced Issues in
Thixatiotl
500 Ots overdue loan is deductible expense (u/s 29

xviiìa, Income Tax Otdinanee 1984). It should be mentioned here that the
provision for 90% allocation and 75% of this deductibility in the liban
Bima Act 1973 applicable for Jiban CotvoNtion does not {itièct the
government revenue as Jiban Bima Cot1)0tï1tion is government
organization which is the only beneficiary itA thc claims do not actually
arise.
Our life instiR11tce companies disclose only current tax. They do not
disclose ('or det'etÑ.l tax which is inconsistent with international and
Banuladesh accounting and auditing standards. Accounting and auditing
standards suggest two types of tax, current tax and deferred tax. ChitTent
tax is calculated on accounting profit. Deferred tax is calculated on the
differences between accounting and tax values of assets and liabilities and
is adjusted for tax credits for past losses, Income tax Ordinance, the Fourth
Schedule requires the actuarial sumlus be adjusted for expenditures not
allowed u/s 29 of the ordinance. This provision indirectly requires deferred
tax provision. Defen•ed tax is an integral part of accounting and taxation.
There are always differences between accounts' profit and tax authority's
profit. Accountants measure profit by following conservatism principle and
capital maintenance theory (please see any text book on these principles
and Hayek 1935 for capital maintenance) and thus want to understate profit
whereas the objective of tax accounting is the opposite, that is to ensure
that, profit is not understated. So accountants' reported profit and tax
calculated thereon will be lower than those of tax authorities. But both
parties are right. Accountants' purpose is not only to understate tax but also
to maintain capital and growth of the business. So business world calculate
deferred tax for this difference knowing that tax authority will not accept
their profit figure, Deferred tax is a must and recognized by national and
international accounting standards (IAS 12). But Popular, one of the
largest life insurance companies in the notes of its financial statements says
that the difference between income tax written down value (WDV) and
accounting WDV is insignificant and they do not make provision for
deferred tax. Delta, another large company, says in its notes to financial
statements "the company does not provide for deferred tax as current tax
has been calculated based on the actuarial valuation and there is no effect
of tax base assets and liabilities." This is however inconsistent with the
Fourth Schedule of Income Tax Ordinance 1984.

Income Measurement and Taxation in Life Insurance Business 196
Table 2. Tax as a percentage of total revenue
Country Mean Variance Standard Coefficient
Deviation of
Variation
(in %
Ban ladesh 1.510000 1.565689 1.251275 82.8659
Rest of the 2.217692 2.767569 1.663601 75.0150
World
t- Test for Equality of Population Means between Bangladesh and Rest of
the World
Count t-Test Probabili
Bangladesh -1.164290 0.25736362
Rest of the World

F-Test for Equality of Population Variances (Upper Tailed Test)
Coun F-Test Prob
Rest of the World 1.76764 0.17668884
Ban ladesh
Backlogs: Conflicts with the NBR
There are big differences among income tax determined by actuarial
v
aluation which is charged to revenue account, provision for income tax in
liabilities shown in the balance sheet and income tax paid in the cash flow
statement (Appendix 3), Actuarial valuation of income tax is much lower
than the other values. Delta's income tax is TK155 million but the
provision at the end shows TK566 million. Its notes to financial statements
say that assessment is under process from the assessment year back from
2004. It means that there are conflicts between the company and the tax
authority over the amount of tax provisions. Again, income tax paid in the
current year is much higher than the tax charged for the year. Similarly,
Meghna's provision of TK329 million and tax paid are much higher than
income tax charged in the current year. Its notes therefore said that the
company filled
appeal with the Appellate of Taxes.Tribunal The against UK the and

assessment USA companies'of the Deputy Commissioner balance sheets
do not have current year tax liabilities because these are duly paid but

there are deferred tax liabilitics, Deferred tax liabilities are liabilities for
differences in accounting and tax methods of profit determination
adjusted for tax benefits of prior period losses. I earlier mentioned in the
methodology that our unit of rne;Bure is current tax and I compare
current tax liability of our life insurance companieq with that of foreign
companies. Actuary determination of tax in our companies is the current
tax liability.
Audit Report
I reviewed the audit reports of the life insurance companies under study
for the relevant years. These reports say that they ha',c audited books of
accounts according to Bangladesh Auditing Standards, the Bangladesh
Financial Reporting Standards, the Securities and Exchange Rules 1987,
the Companies Act 1994, the Insurance Act 2010, the Insurance Rules
1958, But their reports clash with these regulations with one important
requirement that all public limited companies (including life and nonlife
insurance companies) must prepare a profit and loss account. The
Insurance Act 2010 u/s 28 clearly says that the three financial statements
including profit and loss account must be audited by a chartered
accountant firm. The reports say that the company management has
followed relevant provisions Of laws and rules in maintaining proper
books of accounts, records and other statutory books. But this is not true
with regard to the above vital requirement. Our life insurance companies
do not prepare a profit and loss account, Importantly, valuation of
insurance liabilities on the balance sheet date, a significant portion of
values which ranges from 90% to 95% of revenue balance remains outside
the balance sheet.
Laws not to be blamed.

Our Insurance Act 2010 in fact has provision for profit and loss account for
all classes of insurance business (section 27 (1b)). But our companies are
not complying with the regulation. If profit and loss account is prepared
and included in the annual reports, the confusions will be over. Then
accountants, actuaries and auditors will be forced to find how the accounts
add up, because the financial statements follow the double entry system of
accounting, the task which is missing in the existing system. The first
method for profit determination under the Income Tax Ordinance 1984 is
faulty as explained before but this method has never been applied by any

company except in one or two isolated cases. The second method cannot
be blamed for the Income Tax Ordinance 1984 (u/s 2(b) does not say the
ending insurance liabilities be deducted from the ending balance of
revenue account rather it requires surplus or deficit to be determined by
actuarial valuation. Our actuaries continue doing this according to the
insurance Act 1938, the Fourth Schedule although the schedule has been
deleted. It should be mentioned here that even the 1938 Act, the Fourth
Schedule does not measure yearly profit but surplus which is a longterm
solvency of the company. The Income Tax Ordinance 1984 amended up to
2016 defines life insurance according to the new Insurance Act 2010 not
the old 1938 Act. Actuarial valuation of surplus or deficit in life insurance
means using actuarial science in the valuation of claims, determination of
premium, and the preparation of mortality tables. How surplus (profit) or
deficit (loss) will be determined is not the area of actuary science rather it
is the area of accounting. Accounting has its principles and methods for
determining surplus or deficit. Actuary science just helps in determining
the contingencies.
Insurance Development Regulatory Authority (IDRA)
DRA has issued the Circular 4 in 2012: Guidelines for Preparation of
Accounts and Financial Statements where it does not require a profit and
los;9s account. This circular refers to the section 160 (2) of the Insurance
Act 2010 were it says that if any rule under this Act is not yet framed, the
previous rules of the old Act 1938 will prevail. This provision may be
appropriate for issues where there is difference in reality between 1938 and
2010. But profit and loss account is such a financial statement which is
prepared in all public limited companies including life insurance business
everywhere in the world. The basics ofprofit and loss account are well
settled for centuries. The format and basics of profit and loss account are
now universal. There is no need for any more rules in addition to section
27 of our Insurance Act 2010 which specifically requires a profit and loss
account for all insurance companies without exception. The fact that DRA
has issued the circular 4 in 2012 and there had been no rule on section 27
even after four years in 2016 is an indication that there is no necessity of
any rule on such universal financial statement. There is only one unique
item in the profit and loss account of a life insurance business—the
potential claims of insurance policies maturing after the current accounting
period but may fall during the current accounting period. This item is well
captured by the IFRS 4, accounting for life insurance business. India,
Pakistan and Bangladesh had their common insurance regulation from
Britain and under the same regulation all life insurance companies of these

countries except Bangladesh are preparing that basic financial statement-
the profit and loss account.
Conclusion
This article has some important discoveries: first, for the first time In
Bangladesh, it discovered that publicly listed life insurance
companies historically violated the basic accounting fundamentals
by not preparing a profit and loss account and not disclosing profit
and loss 111
their financial statements. Second, our life insurance companies

suppress surplus (a wrong alternative of profit) and thus pay less
income tax compared to that of foreign companies. Third. the parûes
related to this industry and their accounting and taxaún, like the
auditors, the National Board of Revenue and the Large Tax Pavers
Unit, and the Insurance Development Regulatory Authority remained
silent. The article also has an important relevance ;2for accounting
and taxation education in our colleges and universities. Our colleges,
universities and the text books historically have taught the students
the wrong accounting and taxation practiced by our life insurance
companies. This article now corrects these faults and shows the
international accounting and taxation standards and practices.
Insurance Development Regulatory Authority (DRA) would not do the

accounting reform on its own. First, it has other important jobs like
developing mortality table, regulations on claims payment, investment of
ftnd and other disciplining mechanisms for insurance companies. Second,
accounting usually does not fall within their expertise (though experts from
insurance, finance, banking, accounting, management and law may be
members of DRA u/s 7 of the DRA Act 2010). Currently five-member
committee members all have bachelor degree and their training and

experience are non-accounting. One of the objectives of the National
Insurance Principles 2013 is the harmonization of our insurance rules with
international ones u/s 4 (9). Accounting principles and practices are
altogether different from those of actuary science which is the main
expertise of the key members of DRA. Accounting scholars and
practitioners from universities, ICAB, ICMAB and other accounting
bodies must push for the required reform in the existing faulty accounting
and taxation in this vital sector of the economy.
Appendix l, Life insurance companies: profit before tax as a percentage of
total revenue, average of2013 and 2014.
Profit before tax
Profit/Revenue
Bangladesh TK30 miliion TKI 1.65%
813million
Pragati 1764 2.49
Progressive 44 8647 2.66
Popular 230 1809 3.26
Rupali 59 3.84
204 5315
Meghna 8449 2.80
Delta 240
National 367 7906 0.60
Prime Islami 16 2673 5.74
Sandhani 182 3169
India:
LIC Rs.76529 3617683 2.12
ICICI 9987 293916 3.40
Bajaj Allianz 9137 103033 8.87
Reliance 3390 62281 5.44
Tata AIA 2941 43672 6.74
AVIVA £934 38896

Legal and General 1369 45390 3.02
Royal London 407 4373 9.31
USA:
AIG 9934 66640 14.91

Metlife $6428 70757 9.08
Canada:
Foresters 72 1197 6.05
China:
China LifeRMB 5688 70036 8.12
Total revenue
Source: Own calculation from annual reports

Profit before tax of Bangladeshi life insurance companies has been
Bangladesh: calculated by
dividing provision
Pragati TK13 miliion TK1813 0.72% of tax disclosed in
Progressive 19 1764 1.07 Revenue Account
Popular 98 8647 1.13 divided by 0.425
Rupali 25 1809 1.38 (42.5% corporate
Meghna 87 5315 I .64 tax rate).
Delta 102 8449 1.21
Appendix 2. Life
National 367 7906 4.64
Prime Islami 6.73 2673 0.25 insurance
Sandhani 77 3169 2.43 companies:
India: Income tax, total
LIC Rs.60187 3617683 1.66
ICICI revenue and tax as
no provision
a percentage of
Bajaj Allianz 1581 103033 1.53
Reliance no provision total revenue,
TATA AIA no provision average of 2013
38896 1.38 and 2014.

AVIVA £538
Legal and General Income tax Total
Legal and General 420 45490 0.92 Revenue Tax as a %
of Total Revenue
Royal; London
Royal London 77 4904 1.57 Source: own
calculation from
USA:
annual reports
AIG
AIG 1803 66640 2.71
Metlife
Metlife $4865 70757 6.87
Canada:
Foresters
Foresters 19 1197 1.58
China:
China Life RMB 1002 70036 1.43
Issues
ill
1-16
Appendix 3, Backlogs, 2014Provision

Income tax in income tax liability flow
Actuarial valuation
TK53 million million

Bangladesh: TK17 million n/a
Pragati 27
175
Progressive 2012 27 5
103 n/a
Popular 24 62 125
Rupali 85 329 172
Meghna 566
155
Delta
National 132 42
Prime Islami 6 177 66
Sandhani 68
n/a
India:
Rs. 60187 n/a n/a
LIC no provision n/a
ICICI
Bajaj Allianz
SBI
463
£538 563 deferred
Aviva 76
180 deferred
Legal and 217
General 46 deferred 12
Royal London 77
USA:
AIG $1803 $19339 deferred n/a
Metlife 4865 11821 deferred n/a
Canada:
Foresters 19 n/a n/a
China:
China Life RMB 7888 19023 deferred 1923

Source: Own calculation from annual reports
Profit before tax of Bangladeshi life insurance companies has been calculated
by dividing provision of tax disclosed in Revenue Account divided by 0.425
(42.5% corporate tax rate).
Appendix 4. Banks: profit before tax, total revenue, and tax as a percentage of
total revenue, average of 2013 and 2014.
Banks Profit before tax Total revenue percentage

Sonali TK4102 miliion TK59478 million 6.90%
4496
Agrani 41845 10.74
Janata 8244 55955 14.73
Dutch Bangla 4032 20394 19.78
IFIC 3103 15717 19.75
AB Bank 3776 26320 14.35
Source: own calculation from annual reports
Appendix 5. Life insurance companies and banks: Equity including revenue

fund times liabilities (liabilities being claims paid in cash flow statement for
life insurance companies), average of 2013 and 2014
Equity Liabilities Life insurance:

Pragati TK3826 million TK850 million 4.50 times
Progressive 3343 297 11.3
Popular 26755 1938 13.8
Meghna 12995 1900 6.83
Delta 30406 3806 7.99
Prime Islami 6914 881 7.85
National Life
2010-11 19439 2080 9.34
Sandhani 9340 1456 6.41
Banks:
Sonali 54632 731864 0.07
Agrani 37469 365493 0.10
Janata 38241 497269 0.08

Dutch Bangla 13579 155996 0.09
AB Bank 18021 179862 0.10
Source: own calculation from annual reports

Appendix 6. Existing method for surplus/profit or loss (flawed):
in Taxation
148
Revenue account for the year ending 31 December 2015
Balance beginning
Add
Premium income
Interest, rent and dividend xxx
Less
Claims paid and intimated
Management expenses
Income tax
(xxx)
Balance closing
Surplus for the year ending 31 December 2015
Less actuarial valuation of liabilities at the balance sheet date (ending) (xxx)
Surplus
Less allowable deduction for bonus to policyholders, 3/4th of 90% of the above
surplus (xxx)
Taxable surplus
Income tax @42.5%
Appendix 7. International standard for profit or loss account (world experience,

FRS 4)
Profit and Loss Account for the year ending 31 December 2015
Premium income

Interest, rent and dividend income
Less
Claims paid and intimated
New provision for insurance liabilities (brought from provision for
insurance liabilities account below
Management expenses
Income before income tax

Income tax
(xxx)
Net profit
XXX
Balance beginning
Claims paid
(xxx)
New provision
Balance closing
XXX
in Taxation
150
Example co. Ltd has the following data for JanuaryTK1600 million XY Life Insurance
Balance of Account (fund) 1.1.14 TK700 m

Premium less reinsurance (of all policies): 800
First year premium 2

Renewal premium 1502
Reinsurance premium 100 Total
Claims paid and due and intimated (of all policies) less reinsurance: By maturity
TK50 m, by death TK20 m, by survival TKI 15 m
By surrender TK4 m, by others TK3 m 192
Total
500
Expenses of management
Administrative expenses including depreciation 400900 Total
Policies to mature:
Maturity # Policies ofpolicy value age per mortality TKIOOO Qi policy
premiumTK2value
2015 50 0.0020 4
1016
8 1.5 6
6 2 60 0.013
2017
2018 5 4 65 0.0421 8
2019 20 3 70 0.101 10
2020 25 2.5 75 0.1225 12
each 40 0.0016
10
Additional information:
(i) premium due but not yet received:
Policies mature 2016, 2017, 2018: 1 policy each
2019 and 2020: 3 policies each
(ii) management expenses allowed by NBR 35% of gross premium
(similar to percentages in the 4th Schedule, Income Tax Ordinance
1984
(iii) provision for doubtful accounts @5% of premium receivable

and in Insurance Business 207
.lhxatiott l.ìtè
(iv) Ots Ots actuary valuation is allocated bonus to policyholders bilt 4th
or this is allowable deduction discount rate 10%) tax rate 45 0 6
(vii) interest (tiìte ot•tXAturt1 on investments) tÄ1nges from to 12%
RequiÑd:
a) critically explain the Fourth Schedule
b) Revenue account
b) External eamings
c) Aetu:rial valuation
d) Txxable income according to actuarial valuation and determine tax
e) Txxable income according to income statement and determine tax
Solution
a)External are noncore items which cannot be the measure of mainstream
income of a business. All income, core and noncore items are to be
considered for measuring true income of a business. Interest, dividend and
royalties tre two digit million (around TK50 million) compared with
management expenses which is 35% of gross premium amounting to around
3 digit million taka (around TK300m resulting a huge loss.
b) Revenue account
Balance of the fund TK1600 Premium less reinsurance of all policies:
first year premium TK700m renewal premium
800 less reinsurance premium (2)
1498 Interest,
dividend etc. 100 Premium earned but not received:
2015: (4/1000) x 1.5m + (6/1000) x 2m + (8/1000) x4
+ (10/1000) x 7.5m) 0.23 Less claims paid
and intimated (all policies) (192) Management expenses:
Agents' commission TK500m
Administrative expenses including depreciation 400
Total (900) Balance at end 2106

in
152
loo
c) external earnings interest, dividend less
management expenses TK900 but allowed 35%
of gross revenue ofTK1500 (525)
Loss (this is also similar to various percentages (425)
in the IT Ordinance 1984, Fourth Schedule
d) Actuarial valuation
Sum assured ifpaid in 201 :
2015 10 x 2 x 0.0016 0.032m

2016 8 x 1.5 x 0.002 0.024
2017 0.013 0.156
2018 5 x 4 x 0.0421 0.842
2019 20 x 3 X 0.101 6.06 2012 25 x 2.5 X 0.1225 7.656
Total
(14.77)
Less present value of future premium:
2015 (2/1000) x 10 X 2 X 0.909 X (1-0.0016) 0063
2016 (4/1000) x 8 x 1.5 x 2 years X 0.826 X (1-0.002) 0.0796
2017 (6/1000) x 6 x 2 x 3 years x 0.751 x (1-0.013) 0.1601
2018 (8/1000) x 5 x 4 x 4 years x 0.683 x (1-0.0421) 0.4187
2019 (10/1000) x 20 x 3 x 5 years x 0.621 x (1-0.1010) 1.6748
2020 (12/1000) X 25 x 2.5 X 6 x 0.565 x (1-0.1225) 2.231
Total liability
4.6
Net liability
(10.17)
e) Taxable income and tax according to actuary valuation:
Net liability
Revenue account balance
(10.17)
2106.23
90% for bonus to policyholders:
income 2096.061886.45
75% allowable deduction
1414.84)
681.22
306.55
f) Taxable income and tax as per income
statement
Interest, dividend etc.
700 + 800-2
1498
100
_ltteotne Btcasurement Taxation Li/è
Premium accrued
(4/1000) X X (1-0.002) (6/1000) 2 X
(8/1000) x (1-0.0421) (10/1000) x 9 (1-0.101)
(12/1000) x 7.5 x (1-0.1225) 0.208

Less Claims paid and intimated (192)
Management expenses (900)
Provision for doubtful premium ((101 15)
Sum assured if paid (requirement d) (14.77)
Income before tax 585
Add back
Bonus to policyholders 90% 442.03
Allowable deduction 75% of 442.03 331.52
Taxable income 159.62
71.83
Notes:
i) Income statement is better because revenue account balance
(previous balance) is not included here.
ii) Revenue account is in essence the income statement but modified
and improved by actuary science. iii) 90% bonus remains a question.
iv) Policies beyond 2014 are imaginary and made very simple. In reality
all individual policies deserve treatment by actuary valuation.
Questions
l. Critically explain the Fourth Schedule of Income Tax Ordinance 1984,
2. How do life insurance companies in Bangladesh measure profit and
loss?
3, Can there be a PLC without an income statement in its annual report?
Then how do our life insurance companies exist without an income
statement?
4. How do life insurancc companies around the world measure profit
and loss?
5. Explain IFRS 4: accounting for life insurance companies.
in T
154 axati0ä
6. Who are the parties responsible for the faulty Income measurement
and taxation in our life insurance companies?
Exercise

l. Go to the Internet, find the financial statements in the annual report of any
life insurance company in Bangladesh and compare these with

Oil and Gas Industry 12
Chapter Objectives:
Full cost vs. successful effort
Fifth Schedule of I.T. Ordinance 1984 Depreciation,
depletion and amortization
Production sharing contract
Royalties
Taxes
Chevron and British Petroleum
An oil and gas company is granted exclusive rights to exploration and

production of the concession area and owns all oil and gas production.
Under concession an oil and gas company typically pays royalties and
corporate income tax. Other payments to the government may be applicable,
such as bonuses, rentals, resource taxes, special petroleum or windfall profit
taxes, export duties, state participation and others.
Production Sharing Contract (PSC)

Under a PSC/PSA, a national oil company (NOC) or a host government
enters into a contract directly with an oil and gas company. A company
finances and carries out all E&P operations and receives a certain amount
of oil or gas for the recovery of its costs along with a share of the profits.
Sometimes PSC/PSA requires other payments to the host government, such
as royalties, corporate income tax, windfall profit taxes, etc.
Service contracts
Under a service or risk service contract, an oil and gas company finances
and carries out petroleum projects and receives a fee for this service, which
can be in cash or in kind. The fees typically permit the recovery of all or
part of the oil and gas company's costs and some type of profit component.
Royalties (petroleum production tax)

In Algeria, royalties (under PSC) are due on the gross income and are paid
by the NOC at a rate of 20%. The royalty rate can be reduced to 16.25% for

Zone A and 12.5% for Zone B (different zones of the Algerian territory).
The Minisfry of Finance can reduce the royalty rate further to a limit of
10%. In Argentina, royalties are 12% of the wellhead value and deductible
from corporation income tax. Royalties are typically either specific levies
(based on the volume of oil and gas extracted) or ad valorem levies (based
on the value of oil and gas extracted).
Turnover tax
In Argentina, provincial governments impose 2.8% of gross revenue
(turnover) for upstream companies and at a higher rate for service
companies.
Income tax
Income tax at the rate of 38% applies to the profit made by a foreign
partner, and is paid by the NOC on its behalf. In Angola, it is 50% under
PSC and 65% under partnerships. In Saudi Arabia, corporation income for
petroleum is 85% whereas for other business it is 20%. This profit is
calculated by subtracting the royalties paid, transportation costs,
amortization costs (abandonment or restoration) and annual exploitation
and development costs from the gross income. In Angola, costs incurred
before production are capitalized and recognized over a four-year period
(25% per year) from the first year of production.
Debt Financing and Transfer Pricing

To protect the tax base, countries may place limits on the use of debt
financing to limit "earning stripping" through the payment of interest
abroad.6To limit abusive transfer pricing between related companies, the tax
authority should have the power to adjust income and expenses where
under- or overpricing related companies has resulted in a lowering of
taxable profit. Common measures to maximize expenditure deductions
include (i) the provision by related parties of highly leveraged debt finance
at above-market interest rates, (ií) claiming excessive management fees,
deductions for headquarter costs, or consultancy charges paid to related
parties, and (iii) the provision of capital goods and machinery in leasing
arrangements at above-market costs charged by a related-party lessor.
It is important to determine the extent of "ring-fencing" of tax accounts.
Ring fencing means a limitation on consolidation of income and deductions

for tax purposes across different activities, or different projects, undertaken
by the same taxpayer. Some countries ring-fence oil and gas activities,
others ring fence individual contract areas or projects. This can become
complex if a project incorporates extraction, processing and transportation
activities. If the oil and gas tax regime is more onerous than the standard tax
regime, the taxpayer could seek to have certain project-related activities
treated as down-stream activities outside the ring fence. If they are treated as
a separate activity, the taxpayer through transfer pricing may attempt to shift
profits to the lightly taxed downstream activities.
Capital allowances (depreciation)

I
n calculating a company's CIT liability, tax depreciation deductions may be
available. Depreciating assets include assets that have a limited effective life
and that decline in value over time. Examples of depreciating assets include
plant and equipment, certain items of intellectual property, in-house
proprietary software and acquisitions of exploration permits, retention
leases, and production licenses.
Additional Profits Tax (windfall tax)

This tax is due by all entities in a exploration or production contract, based
on the annual profits after income tax. The following expenses are
deductible for the calculation of the taxable basis: royalties income tax,
depreciation, rcservcs for abandonment or restoration costs, There arc two
applicable rates: 30%, and 15% (for profits that are reinvested). This tax
must bc paid by the day that the annual incomc tax return is filed.
Incentives
As a general rule, operations conducted under the former law regime (1986)
and the 2005 regime are exempt from: VAT, Customs duties social
contributions (foreign employees of petroleum companies are not subject to
social security contributions in Algeria if they remain subject to social
security protection in their home country). An exemption from the tax on
professional activity applies to contracts signed under some law. Moreover,

several incentives are provided by Algerian law in order to enhance the
exploration and production of unconventional hydrocarbons.
Investment tax credit

5 % to 10% of qualifying expenditures (acquisition of machinery,
equipments and buildings primarily for use in oil exploration or
production) is available for reduction from income taxes in Canada.
Carry Forward of Losses

The maximum loss that can be carried forward against a year's profit is
25% of the profit in Saudi Arabia. In Bangladesh there is no such limit but
losses in oil and gas industry cannot be carried forward for more than six
years.
Withholding Tax
In Saudi Arabia, there are withholding taxes for royalties and payments to
head office and affiliates. The rates are for 15% for royalties, 5% for rent
and payments for technical and consultancy services, dividends and
interests at 5%, and 20% for management fees.
Accounting
In oil and gas industry, there are exploration costs for drilling, seismic
survey, and development costs for drilling and wells development. These
costs are capital expenditures. In manufacturing and other businesses
capital expenditures are capitalized meaning a portion is charged to income
statement as expcnsc or expired cost and another portion is treated as assets
in the balance sheet. But in oil and gas industry this basic principle of
accounting is not always followed.
Full Cost Method and Successful Effort Method

In full cost method exploration and development costs are capitalized like in
other businesses but in successful effort method, these capital expenditures
are capitalized when the effort (exploration) is successful otherwise

expensed. An unsuccessful exploration such as the cost of a dry well is
written off immediately as a loss. Because of these immediate write-offs,
successful efforts accounting is considered the more conservative method
and used by most large oil companies. Full cost method suggests that the
cost of dry wells is part of the overall cost of the systematic development of
an oil field and thus a part of the cost of producing wells. It is based on the
belief that unsuccessful ventures are a cost of those that are successful
because the cost of drilling a dry hole is a cost that is needed to find the
commercially profitable wells. Under this full-costing method, all costs
including the cost of dry wells are recorded as assets and depleted over the
estimated life of the producing resources. This method improves earnings
performance in the early years for companies using it. Either method is
permitted by IFRS 6.
The Fifth Schedule of Income Tax Ordinance 1984
Profits and losses in oil and gas industry are computed separately from
Other businesses. In addition to section 29 of the law, there are some
unique provisions to be complied with. Expenditures incurred in such
projects but could not find any output, arc trcatcd as losses, These losses
can be set off and carried forward against profits of SUbsequcnt six years,
Depreciation is allowed by the Third Schedule at 100% for below ground
installations and 30% for above ground installations. There is depletion
allowance of of the gross receipts representing the well-head value of the
production from business subject to the maximum of one-half of profits
before such allowance. The industry will make payments to the
government as per agreement. In addition corporatc tax rate is 25% like
companies listed with stock exchanges.
Example
From the following information prepare tax returns of M Petroleum Ltd
for the income year 2015-16,

Number of wells 16000, number of drills 500, oil reserves 200 billion
barrels, beginning inventory 0.8 billion barrels, $25 billion; production
during the year 2.2 billion barrels; ending inventory 0.6 billion barrels;
revenue (sales proceeds) $150 billion; wells exploration costs: drilling $12
b, seismic survey $6 b, others $5; wells development costs: drilling $18 b,
others $11 b; lifting (production) costs S17 b; general and administrative
costs including depreciation of furniture S5 b; selling and distribution
expenses 6 b; balance of deferred (unamortized): exploration costs $60 b,
developments costs $40 b; exploration success rate 28%, development
success rate 75%; other information: (i) the company has a production
sharing agreement with the government where it pays 25% of the
operating income. Requirement: (a) income tax return by full cost
accounting (exploration and developments costs are capitalized, FRS 6);
(b) income tax return by successful effort method (exploration and
developments costs are capitalized when these are successful, otherwise
expensed, FRS 6).
Solution Full cost method
Revenue $150
Cost of sale b
Beginning inventory $25 b
Depletion 15% of 150 22.5
Lifting cost 18
Amortization of exploration costs (60 + 23) x30% 24.9
Amortization of development costs (40 + 29) x30% 20.7
111.1
Closing inventory 1 11.1/(0.8 + 2.2) x 0.6 (22.2) (88.88)
Gross profit 61,12
General and administrative including depreciation 5
Selling and distribution 6
Total operating expense (1 1)
Operating income 50.12
Payment to government on production sharing 25% of 50.12 (12.53)
Income before tax 37.59 Income tax@25% (9.4)
Net income 28.19
Successful effort method
Revenue $150

Cost of sale b
Beginning inventory $25 b
Depletion 15% of 150 22.5
Lifting cost 18
Amortization of exploration costs (60 x 0.3 + 23 x 0.28 x 0.3)19.93
Amortization of development costs (40 x 0.3 + 29 x 0.75 x 0.3)18.52
103.95
Closing inventory 103.95/(0.8 + 2.2) x 0.6 (20.8) 83.15
Gross profit 66.85
General and administrative including depreciation 5
Selling and distribution 6
Total operating expense (11)
Operating income 55.85
Payment to government on production sharing 25% of 55.85(13.96)
Income before tax 41.89 Income tax @25% (10.47) Net income
31.42

Advanced
219
Chevron
Revenue Recognition
Revenues associated with stiles ol' crude oil, natural gas, petroleum and
chemicals products, and all other are recorded whcn title passes to the
customer, net of royalties, discounts and allowances, as applicable.
Revenues from natural gas production from propcrtics in which Chevron
has an interest with other producers arc generally recognized using the
entitlement method. Excise, value-added and similar taxes assessed by a
governmental authority on a revenue. producing transaction between a
scllcr and a customer arc Presented on a gross basis. Purchases and sales of
inventory with the' same counterparty that are entered into in
contemplation of one another (including buy/sell arrangements) are
combined and recorded on a net basis and reported in "purchased crude oil
and products" on the consolidated statement of income.
Capitalized costs
Capitalized costs related to oil and gas producing activities are
unproved properties, proved properties and related producing assets,
support equipments, deferred exploratory wells, and other
uncompleted projects.
Accounting for Suspended Exploratory Wells

The company continues to capitalize exploratory well costs after the
completion of drilling when (a) the well has found a sufficient quantity
of reserves to justify completion as a producing well, and (b) the
business unit is making sufficient progress assessing the reserves and
the economic and operating viability of the project. If either condition is
not met or if the company obtains information that raises substantial
doubt about the economic or operational viability Of the project, the
exploratory well would be assumed to be impaired, and its costs, net Of
any salvage value, would be charged to expense.

Depreciation, Depletion and Amortization

Depreciation, depletion and amortization expenses increased in 2015 from
2014 mainly due to impairments of oil and gas producing fields of about
$3.5 billion in 2015 compared with $900 million in 2014. Also
contributing to the increase were higher depreciation rates and higher
production levels for certain oil and gas producing fields. The increase in
2014 from 2013 was mainly due to higher depreciation rates and
impairments for certain oil and gas producing fields, and the impairment
of a mining asset.
Income Tax Expense

Effective income tax rates were 3 percent in 2015, 38 percent in 2014 and
40 percent in 2013. The decrease in the effective tax rate between 2015
and 2014 primarily resulted from the impacts of jurisdictional mix, one-
time tax benefits, foreign currency re-measurement, equity earnings and a
reduction in statutory tax rates in the United Kingdom, partially offset by
the effects of valuation allowances on deferred tax assets and
the sale of the company's interest in Caltex Australia Limited. The rate
decreased between 2014 and 2013 primarily due to the impact of changes
in jurisdictional mix and equity earnings, and the tax effects related to the
2014 sale of interests in Chad and Cameroon, partially offset by other one-
time and ongoing tax charges.
Excise and Value added Taxes

Taxes other than on income decreased in 2015 from 2014 mainly due to
lower crude oil and refined product prices. Taxes other than on income
decreased in 2014 from 2013 primarily due to a decrease in duty expense
in South Africa along with lower consumer excise taxes in Thailand,
reflecting lower sales volumes at both locations.
Critical Accounting Estimates and Assumptions

Management makes many estimates and assumptions in the
application of generally accepted accounting principles (GAAP)
that may have a material impact on the company's consolidated
financial statements and related disclosures and on the

comparability of such information over different reporting periods. Such

estimates and assumptions affect reported amounts of assets, liabilities,
revenues and expenses, as well as disclosures of contingent assets and
liabilities. Estimates and assumptions are based on management's
experience and other information available prior to the issuance of the
financial statements. Materially different results can occur as
circumstances change and additional infonnation becomes known. The
discussion in this section of "critical" accounting estimates and
assumptions is according to the disclosure guidelines of the Securities and
Exchange
Commission (SEC), wherein: (i) the nature of the estimates and

assumptions is material due to the levels of subjectivity and judgment
necessary to account for highly uncertain matters, or the susceptibility of
such matters to change; and (ii) the impact of the estimates and
assumptions on the company's financial condition or operating performance
is material. The development and selection of accounting estimates and
assumptions, including those deemed "critical," and the associated
disclosures in this discussion have been discussed by management with the
Audit Committee of the Board of Directors. The areas of accounting and
the associated "critical" estimates and assumptions made by the company
are oil and gas reserve, impairment of properties, plants and equipments,
and pension and other retirement benefits.
British Petroleum
Successful Efforts Method
Oil and natural gas exploration, appraisal and development expenditure is
accounted for using the principles of the successful efforts method of
accounting as described below.
License andproperty acquisition costs

Exploration license and leasehold property acquisition costs are capitalized
within intangible assets and are reviewed at each reporting date to confirm
that there is no indication that the carrying amount exceeds the recoverable

amount. This review includes confirming that exploration drilling is still

under way or planned or that it has been determined, or work is under way
to determine, that the discovery is economically viable based on a range of
technical and commercial considerations, and sufficient progress is being
made on establishing development plans and timing. If no future activity is
planned, the remaining balance of the license and property acquisition costs
is written off. Lower value licenses are pooled and amortized on a straight-
line basis over the estimated period of exploration. Upon recognition of
proved reserves and internal approval for development, the relevant
expenditure is transferred to property, plant and equipment.
Exploration and appraisal expenditure

Geological and geophysical exploration costs are recognized as an expense
as incurred. Costs directly associated with an exploration well are initially
capitalized as an intangible asset until the drilling of the well is complete
and the results have been evaluated. These costs include employee
remuneration, materials and fuel used, rig costs and payments made to
contractors. If potentially commercial quantities of hydrocarbons are not
found, the exploration well costs are written off. If hydrocarbons are found
and, subject to further appraisal activity, are likely to be capable of
commercial development, the costs continue to be carried as an asset. If it is
determined that development will not OCCur then the costs are expensed.
Costs directly associated with appraisal activity undertaken to determine the
size, characteristics and commercial potential of a reservoir following the
initial discovery of hydrocarbons, including the costs of appraisal wells
where hydrocarbons were not found, are initially capitalized as an
intangible asset. When proved reserves of oil and natural gas are determined
and development is approved by management, the relevant expenditure is
transferred to property, plant and equipment.
Development expenditure
Expenditure on the consü-uction, installation and completion of infrasü-
ucture facilities such as platforms, pipelines and the drilling of
development wells, including service and unsuccessful development or

delineation wells, is capitalized within property, plant and equipment

and is depreciated from the commencement of production as described
below in the accounting policy for property, plant and equipment.
Income taxes
Income tax expense represents the sum of current tax and deferred tax.
Interest and penalties relating to income tax are also included in the
income tax expense. Income tax is recognized in the income statement,
except to the extent that it relates to items recognized in other
comprehensive income or directly in equity, in which case the related tax
is recognized in other comprehensive income or directly in equity.
Current tax is based on the taxable profit for the period. Taxable profit
differs from net profit as reported in the income statement because it is
determined in accordance with the rules established by the applicable
taxation authorities. It therefore excludes items of income or expense that
are taxable or deductible in other periods as well as items that are never
taxable or deductible. The group's liability for current tax is calculated
using tax rates and laws that have been enacted or substantively enacted
by the balance sheet date.
Deferred tax is provided, using the liability method, on temporary
differences at the balance sheet date between the tax bases of assets and
liabilities and their carrying amounts for financial reporting purposes.
Deferred tax liabilities are recognized for all taxable temporary
difference except: where the deferred tax liability arises on the initial
recognition of goodwill where the deferred tax liability arises on the
initial of an asset or liability in a transaction that is not a
business combination and, at the time of the transaction, affects neither
accounting profit nor taxable profit or loss in respect Of taxable
temporary differences associated with investments in subsidiaries and
associates and interests in joint arrangements where the group is able to
control the timing of the reversal of the temporary differences and it is
probable that the temporary differences will not reverse in the
foreseeable future.
Deferred tax assets are recognized for deductible temporary differences,

carry-forward of unused tax credits and unused tax losses, to the extent that
it is probable that taxable profit will be available against which the
deductible temporary differences and the carry- forward of unused tax

credits and unused tax losses can be utilized except where the deferred tax
asset relating to the deductible temporary difference arises from the initial
recognition of an asset or liability in a transaction that is not a business
combination and, at the time of the transaction, affects neither accounting
profit nor taxable profit or loss. In respect of deductible temporary
differences associated with investments in subsidiaries and associates and
interests in joint arrangements, deferred tax assets are recognized only to the
extent that it is probable that the temporary differences will reverse in the
foreseeable future and taxable profit will be available against which the
temporary differences can be utilized. The carrying amount of deferred tax
assets is reviewed at each balance sheet date and reduced to the extent that it
is no longer probable that sufficient taxable profit will be available to allow
all or part of the deferred tax asset to be utilized. Deferred tax assets and
liabilities are measured at the tax rates that are expected to apply in the
period when the asset is realized or the liability is settled, based on tax rates
(and tax laws) that have been enacted or substantively enacted at the balance
sheet date. Deferred tax assets and liabilities are not discounted.
Deferred tax assets and liabilities are offset only when there is a legally
enforceable right to set off current tax assets against current tax liabilities
and when the deferred tax assets and liabilities relate to income taxes levied
by the same taxation authority on either the same taxable entity or different
taxable entities where there is an intention to settle the current tax assets and
liabilities on a net basis or to realize the assets and settle the liabilities
simultaneously.
Significantjudgments and estimates: income taxes
The computation of the group's income tax expense and liability involves
the interpretation of applicable tax laws and regulations in many
jurisdictions throughout the world. The resolution of tax positions taken by
the group, through negotiations with relevant tax authorities or through
litigation, can take several years to complete and in some cases it is difficult
to predict the ultimate outcome. Therefore judgment is required to
determine provisions for income taxes. In addition, the group has carry-
forward tax losses and tax credits in certain taxing jurisdictions that are
available to offset against future taxable profit. However, deferred tax assets
are recognized only to the extent that it is probable that taxable profit will
be available against which the unused tax losses or tax credits can be
utilized. Management judgment is exercised in assessing whether this is the
case and estimates are required to be made of the amount of future taxable

profits that will be available. To the extent that actual outcomes differ from
management's estimates, income tax charges or credits, and changes in
curent and deferred tax assets or liabilities, may arise in future periods.
Question
l. What is production sharing contract?

2. Why VAT and customs duties are exempt in oil and gas industry?
3. Explain how accounting in oil and gas industry differs from other
manufacturing industries.
4. Explain how taxation differs between oil and gas industry and other
manufacturing industry?
5. What are the major expenditures ofan oil and gas industry?
How are these treated in the financial statements?
6. Differentiate between depreciation and depletion and amortization
with examples from an oil and gas company.
7. What are the capitalized costs of Chevron?
011
8, Explain the revenuc recognition principle of Chevron.

9, Explain the successful efforts method of British Petroleum.
10, Explain British Pctroleum's accounting policy for income tax.
I How does an oil and gas industry use transfer price for tax
avoidance?
12. Explain IFRS 6: accounting for oil and gas industry.
Exercise
l, From the following data of XYZ Oil Company, calculate the net income
under the successful effort method: sale proceeds TKIOO billion; wells
exploration costs: drilling TK8b, seismic survey TK5b, others TK3b;
wells development costs: pipe lines TK14b, others TK7b; lifting costs
TK16b; general & admin costs including depreciation TK3.5b; selling
& distribution expense TK5.5b; depletion allowance 15% of the well-

head value; government share 25% of the operating income; exploration

success rate 26%; development success rate 74%. Assume there are no
inventories.
2. Tulsa Corp. purchased land containing an estimated 4000000 tons of

ore for $8000000. The land will be worth $1200000 without the ore
after eight years of active mining. Although the equipment needed for
the mining will have a useful life of twenty years, it is not expected to
be usable and will have no value after the mining on this site is
complete, Compute the depletion charge per ton and the amount of
depletion expense for the first year of operation, assuming that 600000
tons of ore were mined and sold. Also compute the first-year
depreciation on the mining equipment using straight line method
assuming a cost of $9600000 with no residual value. Also compute the
corporate tax effects in this problem [Needles B. 1996: 486].
3. Diderot Drilling Company has leased property on which oil has been
discovered. Wells on this property produced 18000 barrels of oil during
the past year that sold at an average sales price of 415
'/'
170
per barrel, Total oil resources of this property are 250000

barrels. The Icasc provided for an outright $500000 to the
lessor before drilling could be commenced , annual rental of
$31500. A premium of of the sales every barrel of oil removed
is to be paid annually to the addition, the lesscc is to clean up
all the waste and debris drilling and to bear the costs of
reconditioning the land for when the wells arc abandoned. It is
estimated that this and reconditioning will cost $30()00 [Kicso
and Weygandt, 578].
4. Browse the Internet and find out the Annual Report of 13akhrabidj
Gas Field Company Limited. Prepare an assignment on accounting
and taxation.

Taxation in Banks 14
Chapter objectives:
Theory
High tax rates for banks
Classified loans
Provision for classified loans
Monopoly profit
Code on taxation for banks
The theory

Corporate profit if reinvested helps growth of the economy. But corporate

profits other than reinvestment can be misused mostly through excessive
executive remuneration in the form of bonus, share, share options and other
perquisites which are used for empire building. This behavior of executives
is well settled in agency theory by Adam Smith in his Wealth of Nations,
1776 and then 200 years after by Michael Jensen in his Theory of the Firm,
1976. To curb this greed and self-interest, top personal tax is kept higher
compared to corporate tax rate. In Bangladesh, historically this theory of
taxation was not followed rather the opposite was in practice. Corporate tax
rate is 25% to 42.5% compared to top personal tax rate of 25% (only
recently 30%). Worldwide, corporate tax rate is much lower and top
personal tax rate is much higher.
Why Corporate Tax Rates are so different in Different organizations in
Bangladesh?
There are different corporate income tax rates for different business
organizations including 42.5% corporate tax rate Cor publicly listed banks
and insurance companies, 25% for publicly listed non-financial companies
and 30% for private companies. In Bangladesh there are a total of 59581
companies according to the N13R Annual Report 201314. Corporate tax of
30% applies to 99.5% of our total companies, This is surely a high tax rate
if compared to Asia's average of 21.9%, Europe's 20.5% and global 23.6%.
India and Pakistan however have higher tax rates of 34.6% and 32%
respectively (Appendix l).
Higher corporate tax rate of 42.5% for banks in Bangladesh appear to have
three poor reasons: banks are highly regulated and therefore it is easier to
collect tax, banks are mostly owned by MPs and political leaders and
therefore have some monopoly elements and earn monopoly profits
(Appendix 4), and finally banks are allowed provision for doubtful loans
and advances as tax deductible expense. Provision for doubtful loans is
allowed all over the world by tax laws, national and international accounting
standards, and Basel regulation. IAS 30 (Disclosure in the Financial
Statements of Banks and Similar Financial Institutions) also provides for
specific and general provision for loans and advances. The Basel Committee
on bank supervision also has the same regulation,
Such different corporate rate practices are detrimental to the proper

functioning of market forces as sectoral allocation of resources may be
distorted. If differential tax treatment is ruled out and numerous distinctions

among different taxpayers and different sources of income are eliminated it

is possible to simplify tax administration, improve compliance, and reduce
evasion. Indian tax law also allows provision for loan losses a tax deductible
expense (section 36 (l) (vii) of 1961 Tax Act) but there is no such
discrimination. In India 7.5% of total income before such expense, subject
to the maximum of 5% of doubtful debts and in Thailand 0.25% of total
outstanding loans is allowed as a deductible expense. UK, Canada, Japan
also has similar tax law. In some countries for example, Germany and
Singapore, even
in Taxation
general provision is also allowed. Singapore allows 3% of the

qualifying loans. In UK specific provision for doubtful debts in
nonfinancial sectors by named debtors whose financial status is in
question is allowed as an admissible expense but general provision like
5% of accounts receivable is not allowed (TA 1988, s 74 The
problem with our income tax rules is that our provision is a general
provision not a provision on specific doubtful loans (u/s 29 xviiiaa,
Income Tax Ordinance 1984). Further, one percentage general
provision on total outstanding loans is much higher than 5% specific
provision. Our banks received 13% to 39% provision of profit before
such provision (Appendix 5).
Similarly, the tax rules address one wrong reason by another wrong
reason in Life insurance companies which do not prepare profit and
loss account required by GAAP and FRS. Our companies rather
determine surplus (a wrong alternative for profit) for an accounting
year as a difference between the yearend balance of revenue account
and the yearend estimated long term insurance liabilities. But this
measure includes accumulated balances from the past and therefore
does not relate to the particular accounting period. This surplus is a
measure of long-term solvency of a company and is not the same as
yearly profit and therefore is not a basis for determining corporate tax
anywhere in the world except Bangladesh. The above flaw in
accounting leads to flaws in taxation. The surplus in our companies is
suppressed and statistically and significantly lower than profitability of

foreign life insurance companies. Also corporate tax as a percentage Of

total revenue is lower in our companies compared to foreign companies
even after the fact that corporate tax rate for our life insurance
companies is almost double that for foreign companies (Chowdhury
2016).
These discriminations are the result of flaws in our taxation system. No
democratic country and competitive economy has such system Of
several corporate tax rates. Jordan, Maldives, Morocco, Tunisia, and
Venezuela have such differences (Deloitte 2016). Nepal's corporate
Income tax rate is 25% but for banks and insurance companies is 300
Tax rate in banks is even higher
Corporate tax rate is 42.5% for publicly listed banks and insurance
companies although 25% for publicly listed non-financial companies and
30% for private limited companies. In Bangladesh there are a total of 59581
companies according to the NBR Annual Report 2013-14. Corporate tax of
30% applies to 99.5% of our total companies. This is surely a high tax rate
if compared to Asia's average of 21.9%, Europe's 20.5% and global 23.6%.
India and Pakistan however have higher tax rates of 34.6% and 32%
respectively.
Banks earn monopoly profit

Higher corporate tax rate of 42.5% for banks in Bangladesh appear to have
three poor reasons: banks are highly regulated and therefore it is easier to
collect tax, banks are mostly owned by MPs and political leaders and
therefore have some monopoly elements and earn monopoly profits, and
banks are allowed provision for doubtful loans and advances as tax
deductible expense which is not allowed in nonfinancial business. Private
commercial banks earned 17% median profit on total revenue compared to
median 3% in cement, ceramics and tannery, less than in 3% in paper and
printing, 5% in textile, 7% in engineering, 10% in pharmaceuticals and
chemicals, and 15% in food during 2014-15. Stock market performance
measure, market to book ratio is however, less than those in other industries.
It is 0.8 the mode value whereas it is more than 1 in other industries. It
should however be mentioned that banks do business with depositors'
money and their equity is around 8% of this liability and if common stock
alone is taken then it is only 4% (calculated from balance sheets) Therefore,

this market measure is not a good measure of performance for banking

industry. This measure is effective where equity is the major source of
finance. Equity in other industries is 300% of debt and common stock is
56% of debt. Banks are very closely held family companies and their
turnover of shares as a percentage of total shares is only 0.18% compared to
0.38% in pharmaceuticals and chemicals, 0.73% in engineering and 0.37%
in food industry.
in Taxation
Provision is an international standard

Provision for doubtful loans is allowed all over the world by national
and international accounting and tax standard. JAS 30 (Disclosure in
the Financial Statements of Banks and Similar Financial Institutions)
also provides for specific and general provision for loans and
advances, The Basel Committee on bank supervision also has the
same regulation. In India 7.5% of total income before such expense,
subject to the maximum of 5% of doubtful debts and in Thailand
0.25% of total outstanding loans is allowed as a deductible expense.
Singapore allows 3% of the qualifying loans. The problem with our
income tax rules is that our provision is a general provision not a
provision on specific doubtful loans, General provision on total
outstanding loans is much higher than specific provision on
nonperforming loans.
Excess provision
Our banks follow the Bangladesh Bank and international standard for
loan classification and provisioning: unclassified 1% to 2%, special
mentioned account 5%, substandard 10 to 25%, doubtful 50 to 75%
and bad 100%. However, since nonperforming loans and advances are
higher compared to other countries the provision is also higher. This
provision for accounting purpose is rational but the tax authority
cannot allow such nonperforming loans. The problem is that our
Income Tax Ordinance 1984 u/s29xiiiaa allow for tax deduction @1%
of total outstanding loans and advances or banks' actual provision
whichever is lower. In countries where nonperforming loans are

higher the tax laws give a cap like certain percentage of profit, for
example, in India it is 7.5% of profit. I have studied fifteen of our
private commercial banks which received an average admissible
deduction Of 26.1% of profit before provision and tax. The Banks
earn much higher than other industries so the liberal tax provision in
line with actual accounting provision is not justified. Worldwide,
provision for tax purpose is lower than that for accounting purpose
because accounting estimates a conservative profit but tax authority's
purpose is to see that the reported profit is not understated.
Zero sum game
Government is charging 42.5% on banks which are higher by 17.5%
compared to other publicly listed companies and by 12.5% compared to
private limited companies. But at the same time it loses tax revenue of
11.1% (26.1% provision x 42.5% tax rate) of profit before tax for provision
of doubtful loans, the provision which is not allowed in nonfinancial
business organizations where only actual bad debts are allowed, So if we
deduct 11.1% from 42.5% it is 31.4%, almost the same as private
companies' tax rate.
Rationalization of tax laws

The gain from higher tax rate is offset by provision for doubtful loans and
advances. But both the separate higher tax rate for banks and excess
provision for doubtful loans are unjustified from taxation, economics and
even from accounting points of views. Such different corporate rate
practices are detrimental to the proper functioning of market forces as
sectoral allocation of resources may be distorted. If differential tax
treatment is ruled out and numerous distinctions among different taxpayers
and different sources of income are eliminated it is possible to simplify tax
administration, improve compliance, and reduce evasion. All functioning
democracies and competitive economies have a standard corporate tax rate.
Again, tax rule for provision on total loans is faulty because provision is
meant for the nonperforming loans not on total loans including good loans
subject to a maximum of certain percentage of profit.

Government can earn extra revenue

If tax rate is rationalized and brought in line with that of international or
even with neighbors, government can raise extra revenue without even
hurting the banking sector (because banks earn monopoly profit). On one
conservative estimate, it can raise an extra TK83 million every year from
each bank (average profit of TK 5668 of a bank x the difference between
our provision and Indian provision (0.261-0.075) x the difference between
our tax rate and Indian tax rate (0.425-0.34.6). in
Appendix 1. Profitability and Market to Book Ratio in Banks alid other

Industries
Profile A: Profit before tax as a percentage of total revenue (interest income

plus other income), average of 2014 and 2015. First five business
organizations listed in the Financial Express from each industry.
Banks:
AB Bank 16%, City Bank 190/0 IFIC 13%, Islami Bank 17%, National
Bank 20%, Pubali 240/0, Rupali UCB lilìl.
19%, Alarafa 19%, Prime 11%, South 23%, NCC
15%, Agrani 2%, Janata 11%, Sonali 3%
Pharmaceuticals and Chemicals:

ACI 10%, ACME 12%, GSR Bangladeshi Ibn Sina
7%, square 25%, Beximco
Food:
Apex Food 2%, Olympic Food 16%, Bangas ISO,G, Fu-Ä,Vang's 150/0
Engineering:
Aftab Automobiles '12%, Eastern Cables Singer Bangladesh 7%, Atlas
Bangladesh 7%, BD Thai 8%

Cement:
Heidelberg Cement 16%, Confidence 12%, 'Meghna 3%, Aramit 3%
Textile:
Al Haj Textile 10% Style Craft 2%, Rahim Textile 5%, Saiham Textile
Ceramics:
Standard Ceramics 30 0, Fu Wang Ceramics 7%, Shinepukur 0%

in Banks 235
Tannery:
\pes Tannery 30 Bata Shoe 1306, Apex Foot 30/0
Paper and Printing:

lakkani Pulp and Paper 00 0, Khuln:t Printing and Packaging 3%
Telecommunication:
Phone 330 BSCCL 440/0
India
ICICI Bank 200/0, IIDFC 18%, Axix Bank 25 0/0, Yes Bank
Banks Provision PBPT Percentage

AB Bank 667 2759
Dutch Bangla 671 5171 13
City Bank 1381 5942 23
IFIC Bank 1166 2967 39
Islami Bank 4643 13498 34
National Bank 1560 7903 20
Pubali Bank 2093 6194 19
Rupali 561 1022 55
UCB 1197 8291 14
Profile B: Market to book value ratio reported in thc Financial Express:
Mode value
Others: greater than I
Source: Own calculation from annual reports of the respective business

organizations
Appendix 2. Provision allowed by the NBR for bad and doubtful loans
and advances, the lower of actual provision or 1% of the outstanding
loans and advances in Million Taka, 2015
750
3480 22

Uttara 1272 5070 25

EBL 1489 6559 23
Alarafa 1538 4517 34
Prime 1580 7718 20
SouthEast 1012 3928 26
Dhaka
1009 3372 30
NCC
Source: Own calculation from the annual reports,

PBPT: profit before provision and tax
Appendix 3. Turnover of shares as percentage of total shares, banks

and other industries February 2017
Traded Shares in million Total shares in million Percentage

Banks 44 25000
Pharmaceuticals 13 3400 0.38
Engineering 19 2600 0.73
Food 2.4 650 0.37
Source: Compiled from the Financial Express, February 2017,
The code of practice on taxation for banks in UK

The code
l. Overview
The government expects that banking groups, their subsidiaries, and
their branches operating in the UK, will comply with the spirit, as well
as the letter, of tax law, discerning and following the intentions Of
parliament. This means that banks should: (i) adopt adequate
governance to control the types of transactions they enter into, (ii) not
undertake tax planning that aims to achieve a tax result that is contrary

to the intentions of Parliament, (iii) comply fully with all their tax
obligations, (iv) maintain a transparent relationship with HM Revenue
and Customs (HMRC) .
2. Governance
The bank should have a documented strategy and governance process
for taxation matters encompassed within a formal policy. Accountability
for this policy should rest with the UK board of directors or, for foreign
banks, a senior accountable person in the UK. This policy should
include a commitment to comply with tax obligations and to maintain an
open, professional, and transparent relationship with HMRC.
Appropriate processes should be maintained, by use of product approval
committees or other means, to ensure the tax policy is taken into account
in business decision-making. The bank's tax department should play a
critical role and its opinion should not be ignored by business units.
There may be a documented appeals process to senior management for
occasions when the tax department and business unit disagree.
Tax planning
The bank should not engage in tax planning other than that which
supports genuine commercial activity. Transactions should not be
structured in a way that will have tax results for the bank that are
inconsistent with the underlying economic consequences unless there
exists specific legislation designed to give that result. In that case, the
bank should reasonably believe that the transaction is structured in a
way that gives a tax result for the bank which is not contrary to the
intentions of Parliament. There should be no promotion of arrangements
to other parties unless the bank reasonably believes that the tax result of
those arrangements for the other parties is not contrary to the intentions
of Parliament. Remuneration packages for bank employees, including
senior executives, should be structured so that the bank reasonably
believes that the proper amounts of tax and national insurance
contributions are paid on the rewards of employment.
4. Relationship between the bank and HMRC

Relationships with HMRC should be transparent and constructive

based on mutual frust wherever possible. The features of this
relationship should include: (i) disclosing fully the significant
uncertainties in relation to tax matters, (ii) seeking to resolve issues
before returns are filed whenever practicable, (iii) Where the bank is in
doubt whether the tax result of a proposed transaction is contraw to the
intentions of Parliament, to help the bank form its reasonable belief
under section 3, it may discuss its plans in advance with I-IMRC."
Practical issues
The code requires banks to have a tax strategy. In a separate
development, all large companies and partnerships, including banks
are required not only to have a strategy but to publish their tax strategy
online before the end of their first financial year beginning after 15
September 2016. To date, no banks have been named by HMRC as
breaching the code. However, it may only be a matter of time before
the first bank falls foul of the code and has its name published. Clearly
this could have significant reputational issues. With HMRC's attitude
to tax planning hardening in the face of political and public pressure to
clampdown on tax avoidance, banks need to keep the code firmly in
mind in all their tax dealings.
Bangladesh Bank Regulations for Loan Classification and

Provisioning
The regulation aims to strengthen banks' credit discipline and improve
the recovery position of loans and advances by the banks by
introducing several circulars that cover: (i) loan classification, (ii)
suspension of interest due, and (iii) making of provisions against
potential loan loss. Provisioning guidelines are (i) bring classification
and provisioning regulation in line with international standards by
undertaking a phase-wise program for loan classification and
provisioning; (ii) enable banks to have all existing information on the
subject in one place by incorporating all instructions issued from time
to time. The circular requires (i) loans are classified into four types: (i)
continuous, (ii) demand, (iii) fixed term and (iv) short-term

agricultural and microcredit. It describes the accounting of the interest

of classified loans and their classification into sub-standard (3 to 6
months overdue), doubtful (6 to 9 months overdue) and bad (more than
9 months). It also describes the following basis for loan classification:
(i) objective criteria such as: past due/overdue, unclassified loans,
"Special Mention Accounts," default installments, etc, (ii) qualitative
judgments that take over when quantitative judgments cannot be used.
This occurs if: (i) doubt arises with respect to recovery of a loan, (ii)
there are situational changes in the stipulations of the terms of a loan,
and(iii) norms of re-scheduling are violated. Rates of provision for
unclassified loans (overdue less than 2 months) are: 0.25% against
SME, 2% on housing finance, and 5% for consumer financing and for
classified: 20% for substandard, 50% for doubtful and 100% for bad.
Example
XYZ Bank has the following outstanding loan for the year 2014-15
Classified Loan:
Substandard (3 to 6 months overdue): TK400m,
Doubtful (6 to 9 months overdue): TK 300m
Bad (more than 9 months overdue): T1<200
The bank provides 2% for unclassified, 20% for substandard,
50% for doubtful and 100% for bad loans.
Net income before tax TKl 500 million
Corporate tax rate 42% Requirements:
i. Provision for bad and doubtful debt ii. Corporate tax savings
i
ii. Excess current tax provision if tax rate for other public
limited companies is 25% iv. Net benefit or loss for NIZ
compared to other PLCs Solution
Provision = 600 x 0.2 + 400 x 0.5 + 200 x I TK52()
million
= 520 x 0.42 ii.
Corporate txx savings on provtstons
TK21S million

iii. Excess current txx provision ofMZ — provision for

other PLCs
520 — 200 x 1 (for bad loan only) = TK320 million
iv. Excess tax savings = 320 x 0.42 = TK134 million
Net benefit or loss = excess tax charge — excess tax
= 1500 (0.42-0.25)- 134 = 255 - 134 = TK121

million
Questions
l. corporate income tax rates are higher in
Bangladesh?
2. Banks earn monopoly profits. Do you agree? Explain with evidence.
3. Why banks earn monopoly profit? Explain
4. are tax laws relating to provision on classified loans in Bangladesh?
5. N
That are tax laws relating to provision on classified loans in
South Asia?
6. Critically explain Bangladesh tax laws on provision for classified
loans in the context of South Asian experience,
7. Corporate income tax is higher in banks compared to other
industries but at the same time allows provision for doubtful debts
in banks which are not available in other industries. DO you think it
is a zero sum game? Explain critically.
8. What are the tax codes for banks in UK?
9. Does Bangladesh need a tax code for banks? Explain critically.
Exercise
l. MZBank has the following outstanding loan for the year 2015-16
Classified Loan:
Substandard, 3 to 6 months overdue: TK600m,

Doubtful, 6 to 9 months overdue: TK400m

Bad, more than 9 months overdue: TK200
The bank keeps provision 20% for substandard, 50% for doubtful
and 100% for bad loans.
Net income before tax TKI 800 million
Corporate tax rate for banks 42%, other PLCs 25% Requirements:
i. Provision for bad and doubtful debt
ii. Corporate tax savings iii. Excess
current tax provision iv. Excess tax
savings
v. Excess benefit or loss

Designing
Remuneration
Structure and
Taxation
Chapter objectives:
Mutual benefit
Cash
Deferred
Fringe benefits
Share options
Nontax factors
Profit sharing bonus
Remuneration of employees includes salary

and benefits. Benefits that are discussed in this chapter
include cash bonus, share options, Ž provident fund, and
insurance policies. Bonus is usually paid as incentive
bonus for good performance of the employer and the
employee. Share options are shares offered to employees
at a certain price (exercise price) for a certain years
usually ten years in UK (in Bangladesh there are no share
options). Provident fund is contributory both by the
employer and the employee, Employer's portion is the income
for the employee which is tax exempt. Premium of insurance
policies and meals are two examples of fringe benefits.
Benefits can be taken in cash when offered or

deferred for investment and profit. employee
may decide to save his current bonus and other
benefits by agreeing with the employer to defer
the receipt of these benefits until some future

date. The employer shall invest the amount in

profitable channels and accumulate the principal
and interests and profit in the employee's
account. One important
motivation for receiving cash in the curent period
or deferring depends upon the tax consideration,
both income tax and capital gain tax.
Mutual benefit
Cash or defer strategy must be mutually
beneficial both for the employee and employer.
The tax consequcnccs of both the employer and
the employee must be considered. Employees will
look for a time when tax rate is the lowest but
employers will look for a time when the corporate
tax rate is the highest in order to get maximum tax
savings. Both the current and future tax rates of
the employee and the employer must be
considered. There are also non-tax factors. For
example, bonus is paid mainly for incentive
purpose not tax purpose. Insurance policies for
employees and their premium are tax deductible
expense for the employer but these involve
separate administration expense and therefore cash
benefits may be given to avoid this responsibility.
Tax considerations
If the employee takes cash he pays income tax at
current rates (tpo) but if he defers he pays income
tax at future rates (tpn). And deferring and
investing for example in shares may bring capital
gain and taxed at lower rates (tcg) or exempted. In
evaluating whether cash benefits are preferred over
deferred benefits, both the current and future tax
rates of both employees and employers (tco) and

(tcn) must be taken into account. Also the different

rates of return on investment by employees (rp)
and by employers (re) change the decision.
Cash
Employee receives cash today (I-tpo) where tpo is

personal tax rate in the current year
Employer's net cost is (I-tco) where tco is the

corporate tax rate in the current year
Deferred
Employee receives where
tco is the corporate tax in the current year, and
rcnis the rate of return on investment at n period,
and tpn is the personal income tax at n period
Fringe benefits: meals, insurance policy

When provided by employer (1 -tpo)
When self purchased (I-tpo) = x (1-tpo),

employee must receive x amount of benefit to be
neutral to (1 -ho) because x is not exempted
(insurance premium gets tax credit on
investment, though).
Cash bonus versus stock option benefit

Cash bonus = (1-tpo)
Stock option = (1-tpn) for regular income and (l

-tcg) for capital gain tax where tcg is capital gain
tax.

Example 1
Your employer is considering to pay you deferred
benefits in 3 years or a cash bonus today. Other
information: tpo = 30%, tpn = 35%, 35%, tcn =
25%, discount rate 10%
Highest deferred benefits from the employer =
3
= 0.86
Minimum deferred benefits if the employee takes cash and then
invest
p 3= 0.93
Mutually beneficial contract amount when net employment costs

at tcn
= net employment costs at tco
Dn(l-tcn)
=
{(1+r
cnY}
1.331 x 0.87 = 1.16
Nontax Factors
Deferred benefits may be better for the employees
by tax considerations but there are nontax factors
like they may switch to other employers or their
current employers may face serious uncertainties in
future that may risk their deferred benefits.
Employers also may not agree with the employees
regarding fringe benefits like insurance policies
which are nontaxable at the hands of employees
but employers may prefer cash benefits instead as

they may think these involve some extra

administrative work.
Share Option
Share option benefits to employees are common in the
developed countries. Bangladeshi public limited companies
do not offer this benefit. Share ownership benefits are
available in few companies but Share option benefits are
entirely absent; some multinational companies may offer
though. Share options are different from share ownership
benefits. A company may give option to its employees to
buy the company's shares at certain price for a period of
minimum of three years. This option benefit may encourage
the employees to work hard for the increase in the
company's share price. For simplicity, benefit of the
employees is the difference between the exercise price (the
price at which option was given) and the market price when
the option was exercised. Suppose option price or exercise
price on the date of option given, say in 2005 is TK200 a
share and the market price on exercise date, say 2008 is
TK500, then his option benefit his TK300. But the issue is
not so simple. The question remains when this remuneration
benefit should be recognized for the employees and when
this remuneration expense be an allowable deduction for the
company. To address this issue there is an option valuation
model called Balack-Scholes model. This model takes into
effect: current market price, option or exercise price,
variance of the stock, option time or maturity, risk-free
interest rate, and the model is based on normal distribution
where the share price moves randomly.
Option valuation by Black-Scholes Option
model

Ln (pix) + [rf+
8/2)] t
where d2 = dl - ,ðdt
International Financial Reporting Standard

(FRS 2) provides for the accounting of this
share-based payment. It requires these benefits
be recognized in the financial statements like
other remuneration expenses. The benefit
relates to the option period and therefore is
expensed (allocated) over the option period.
Example 1
On January l, 2005, XYZ Co. Ltd grants
company's executives the options to purchase
10000 shares of the company's TKIOO par value
common share. The options may be exercised at
any time between 3 to 10 years of the grant date.
Other data: market price of share at grant date TKI
60, exercise price TKI 60, variance of the stock
return 0.12, risk-free interest rate 6%. Determine
(i) value of option using BlackScholes option
model, (ii) journal enfi•y to record the
remuneration expense in December 31, 20005,
(iii) journal entry to record the exercise of 20% of
the options exercised in 2008.
Solution
(i) Option value, 2005
Ln (p/x) + [rf+ 8/2)] t

Ln (160/160) + [0.06 + 0.12/2] 3

1
- 0.6 40.12
d2 = 0.6 - 0.6 = o
V = 160 [ N
(0.6) - 160 N =
160 [ N (0.6) -
160 x 0.835 x N
= 160 X
0.726- 160 x
0.835 x 0.5
= 116.16-66. 8
= TK49.4
Note: probability of the area 0.60 - — (0.5 + O.

2257) or 0.726 and probability of the area 0 = 0.5
+ 0 = 0.5. these values are taken from the
Standard Distribution Function Table.
Salary expense, 2005:

Salary or remuneration expense dr TIC
164533
Paid in capital cr TK164533
(49.4 X 10000)/3
= TK164533]
(iii) Exercise of option, 2008

Cash (2000 X 160) TK320000
Paid in capital- share option
(20% of TKIOOOO x TK49.4) 98720
Common share capital 2000 x
100 cr 200000
Paid in capital in excess of par cr 218720

Profit Sharing and Tax Benefits

Profit sharing benefit is an employment cost of
the employer where he shares some of his profit
with the employees. This employment cost in
return brings some benefit for the employer: (i) it
motivates the employees to work hard, (ii) it
brings alignment between the interests of the
employer and the employee, (ii) it reduces
monitoring costs like audit, supervision and
bonding costs. An employer can design a profit
sharing scheme in three ways: (i) a certain
percentage say 10% of profit before tax, (ii) a
certain percentage say 40% before tax after
deducting a minimum return necessary for the
investment, (iii) a certain percentage say 40% of
profit before tax subject to a maximum bonus of
say three months' basic pay. The first method
suffers from the fact that it does not consider the
minimum performance or benchmark. The second
method has the problem of 'big bath' the term
used by Healy (1985). Here because of a
benchmark, the accountant may attempt to show
losses in the current year by accelerating some
discretionary expenses ol' the following year if he
forecasts that there will not be any profit in the
current year anyway. As a result he can show
maximum profit in the following year. The third
scheme the problems in the other two
methods by incorporating an upper level or
maximum available bonus in order to attack the
unlimited income manipulation behavior of the
accountant.
The profit sharing bonus can be given in cash or
in shares and both are considered tax allowable
expense. If corporate tax rate is 25%, then the
net cost is
(l - 0.25) or 0.75 in a taka

If bonus is given in shares it is good for both

the employers and employees. Dividend is
taxable at a maximum of 20% and capital gain
on sale of shares is taxable only at 10% and in
some cases exempt.
Questions
l . Explain the various components of employee
remuneration.
2. Would you take cash benefits from your
employer now or defer for future?
Explain.
3. Explain the relevant tax laws for employee
remuneration and benefits in the Income Tax
Ordnance 1984.
4. What are the non-tax factors for bonus
and fringe benefits from the employer's
side?
5. Why might salary (cash benefits) be
preferred to deferred benefits even though
employees' tax rate is falling over time?
6. In the developed countries there are share
option benefits for the employees but still
absent in Bangladesh. What are share
option benefits? Why are these absent in
Bangladesh?
7, How shall you determine share option benefits?
8. What tax considerations are involved in share options for
both the employers and employees?
Exercise

l. Suppose you will retire in 8 years. Throughout your life you will
face a tax rate of 30% and earn an after-tax rate of return
of 8.5% on your investments. Your
company's pension plan earns a 11.5%
return, and the company itself earns
10.2% after-tax return on its own
projects. The company faces a current tax
rate of 27.5% and will face a 32% rate in
year 8. How much in deferred
compensation would the company have
to pay you in year 8 to make you
indifferent between future compensation
and a TK1500 increase in salary now?
2. The employer has done a life insurance
policy for the employee with yearly
premium of TK4000. If the employees do
the insurance policy by himself then how
much benefit he shall demand from the
employer? Assume tp0 = 30%.
3. You have two options from your
employer: cash benefits today or deferred
benefits in 5 years. Other information: tpo
— 25%, tpn = 30%, tco = 35%, tcn =
25%, return on investment by the
employee, rp = 11%, return on
investment by the employer, rc = 11.50%,
discount rate 10%.
Required: (i) highest deferred benefits
from the employer, (ii) minimum deferred
benefits if the employee takes cash and
then invest, (iii) mutually beneficial
contract and the amount.
4. Employer-paid health insurance
premiums are deductible expense for the
employer and tax free to the employee.
Suppose instead only first TKIOOOO of
such premiums are nontaxable, If the

employee is in the 15% tax bracket, how

much would the employer has to pay in
cash to make the employee indifferent
between the cash and TK30000 of health
insurance premiums?
5. On November l, 2004, Columbo
Company adopted a share option plan
that granted options to key executives to
buy 30000 shares of the company's $10
par value common stock. The options
were granted on January 2, 2005, and
were exercisable 2 years after the date of
grant if the grantee was still an employee
of the company. The options expire 6
years from the date of grant. The option
price was set at $40.
Requirements: (i) Compute the fair value of
option by Black-Scholes Option Model, (ii) How
much employment expense does the company
charge in the income statement for the year 2005?
(iii) How much of this expense is tax deductible?

Predicting Marginal Tax 16
Chapter objectives:
Concepts of marginal tax, implicit tax and explicit tax
Probability
Present value
Estimating marginal tax rate
Deferred tax
Increase and decrease in marginal tax
Marginal tax deals with future tax while statutory tax deals with
historical tax. Marginal tax is the present value of current plus deferred
income taxes (both explicit and implicit) to be paid per dollar of
additional (or marginal) taxable income (where taxable income is
grossed up to include implicit taxes paid (Scholes et. Al (2002: 157).
Explicit tax is the statutory tax. This marginal tax, implicit and explicit
is important because a new investment project to start commercial
production usually takes around two to three years. So, current statutory
tax rate is not relevant for this potential investment project. Statutory tax
rate considers the explicit tax only whereas marginal tax considers both
implicit and explicit tax. Marginal tax approach predicts the future tax
rate that will be relevant for future business operations. There are many
reasons for which current statutory tax rate will change, for example,
discount factor, probability, and changes in statutory rate, allowable
deductions, setoff and carry forward of losses, and investing and
financing decisions.
Implicit tax can be taken as an opportunity cost and is added to

explicit cost to find the total marginal tax. Implicit cost is the
difference between the rate of return of a tax disfavored
investment and the return
of a tax favored investment. For example, investment in a fully taxable
investment returns 12% whereas investment in tax favored government

savings certificates returns 11%, then implicit cost or implicit tax is 1%

or (120/0-11%).
Example I
Statutory corporate tax rate in 2017 is 25%. From 2019 the tax rate
is 70% probable to be 23% and another 30% probable of being
22%. Discount rate is 10%. What will be the marginal tax rate in
2019?
Marginal tax in 2019 = (statutory rate in 2019 x probability)/(1+r)2
— 0.227 X 4--2-1 = •J_

iBz6
Example 2
Assume an extra income of TKI.OO looses an exemption of TKO.
10 permanently and another loss of exemption of TKO.40 for 5
years. Statutory current tax rate is 30% and will be 32% in next 5
years. Discount rate is 10% and will prevail. Calculate his
marginal tax rate in year (a) 4 and (b) 5.
Solution
Extra income TKI.OO
Lost exemption permanently 0.1
Lost temporary exemption 0.4
Total extra income 1.5
Extra tax = TK1.5 x = TKO.45.
(a)The present value of lost exemption of
TKO.4 in year 4 = (0.4 x
4
071-8-7---
= 0, 128 x
The overall increment to tax on the extra taxable
income = 0.45 — 0, 1-8-7 = 3 T. in
204

year
—
0.128
(b) The present value of lost exemption of

TKO.4 in o"
Example 3
Suppose the statutory tax rate is 35%. You invested in two
projects one fully taxable giving a return of 12%, another partly
taxable or tax favored with a return of 11%, and the other totally
tax free with a return of 10%. Consider discount rate of 9%.
Calculate the marginal tax rate in year 3.
Solution
Here explicit tax rate is = 35%.
Implicit rate for the tax favored asset compared to the fully
taxable asset which is a benchmark asset
Implicit tax for the nontaxable asset compared to the benchmark

asset
Total marginal tax in year 3 = present value of implicit tax +

present value of explicit tax
(0.01/1.093 + 0.02/1.093) + 0.35/1.093
= (0.007 + 0.015) + 0.270 = 0.292 = 29.2%
Deferred tax
To determine marginal tax companies must include implicit taxes
like the present value of deferred taxes. The deferred tax liability
represents a future tax payment a company is expected to make to
appropriate tax authorities in the future, and it is calculated as the
company's anticipated tax rate times the difference between its
taxable income and accounting earnings before taxes. Deferred

tax asset is an accounting term that refers to a situation where a

business has overpaid taxes or taxes paid in advance on its
balance sheet. These taxes are eventually returned to the business
in the form of tax relief, and the over-payment is, therefore, an
asset for the company.
Deferred tax = (difference between the value assets as per book and as
per NBR) x statutory tax rate
Deferred tax = (difference between liabilities as per book and as per

NBR) x statutory tax rate
If the book value of assets is greater there is dcfcrrcd tax asset because
lesser expenses were charged than allowed by NBR. If book value of
assets is lower then there is deferred tax liability becausc more expenses
were charged than allowed. The opposite happens in case of liabilities.
If the book value of liabilities is greater then there is deferred tax
liability because more cxpcnscs were charged than allowed. If the book
value of liabilities is lower then there is deferred tax asset because lesser
expenses were charged than allowed.
Example 4
Suppose next year every one taka increase in depreciation results an
accounting depreciation of TKO.02 and tax purpose depreciation of
TKO.OI, and an increase of perquisites results an accounting perquisites
of TKO.004 and tax purpose perquisites of TKO.003. Calculate
marginal tax rate in year assuming explicit tax rate of 35% and discount
rate of 10%.
Solution
Deferred tax liability

Accounting depreciation 0.02
Tax office depreciation 0.01
Difference 0.01
Accounting perquisites 0.004 Tax office perquisites
0.003

Difference 0.001
Total difference and deferred tax liability 0.011
Marginal tax rate = 0.011/ 1.1 + 0.35/1.1 = 0.01 + 0.318 = 0.328 =

32.8%
ill
206
Setoff and Carry Forward of Losses

Net operating losses can bc catTicd forward and set off against income
for a total period of six years according to our tax laws (u/s 3742),
business can reduce its marginal tax using this provision of law,
Example 5
A firm has incurred a loss of TVmillion in 2017. The statutory tax rate
today is 25% and 22% in future. The company is expected to earn TK2
million in 2018 and TK3 million in 2019. Discount rate is Determine
marginal tax rate.
Solution
Marginal tax = 0.22/1.082 = 0.188 = 18.8% (the firm will start paying tax in
year 2)
Increase and decrease of marginal tax

Marginal tax rates will be lower when (i) statutory tax rates decrease or
remain constant, (ii) allowable deductions increase, (iii) tax credits
increase, (iv) deferred tax asset arises, (vi) net operating losses can be
carried forward and set off, (v) discount rate decreases. Marginal tax
rates will increase when (i) statutory tax rates increase, (ii) allowable
deductions postponed, (iii) tax credit postponed, (iii) deferred tax
liability arises, (v) set off and carry forward of losses postponed, (v)
discount rate increases.

Reducing tax treatment uncertainty

Companies can request advance ruling from the tax authority on how a
proposed transaction will be treated for tax purposes. Professional legal
opinion also can help,
Questions
1. Differentiate between statutory tax rate and marginal tax rate.

2. What factors determine marginal tax rate?
3. How do reductions in allowable expenses affect marginal tax?
4. How do increases in tax credit affect marginal tax?
5. What alternative investments can firms use to change their
marginal tax rate?
6. What alternative financing instruments can a firm use to change
its marginal tax rate?
7. How does deferred tax asset affect marginal tax rate?
8. How does deferred tax liability affect marginal tax rate?
9. Determining a firm's marginal tax rate is very difficult. Do you
agree? Why?
10. How shall a firm reduce tax treatment uncertainty?
11. How is the marginal tax rate affected when current tax rules
reduce tax deductions by a fraction of incremental income?
12. How is the marginal tax rate affected when tax rules postpone
current tax deductions or tax credit by a fraction of incremental
income?
Exercises
1. A firm has incurred a loss of TK5 million in 2017. The

statutory tax rate today is 25% and 22% in future. The company
is expected to earn TK3.5 million in 2018 and TK4 million in
2019. Discount rate is 8%. Determine marginal tax rate.
2. Suppose a firm has a loss in the current period of TKIO million

which when added to prior losses give it an NOL carry forward
of TK15 million. The top statutory tax rate for the foreseeable

future is 35%. Assume an after-tax discount rate of 10% and

future taxable income per annum of TK2 million. What is the
firm's marginal explicit tax rate? [taken from Sholes 2002: 177]
in
20s
3. A firm is equally likely to earn profit TK6 million or loose TK4

million this year. Statutory tax rate is 35%. Detemine the firm's
expected marginal tax rate.
4. Assets as per balance sheet are TK25 million and as per NBR
TK20 million. Liabilities as per balance sheet are TK12 million
and as per NBR TK8 million. Calculate deferred tax asset or
liability assuming corporate tax rate 45%.
5. Suppose a firm has a tax loss of T$5 million in the current

period. The firm's after-tax discount rate is 10%. Over the
preceding 5 years the firm has reported the following taxable
income:
Year
-3 -2 -1 current
Taxable income
(loss) in million $ I 1 1.5 3 3 (5)
Statutory tax rate 40% 40 35 35 30 30
Requirements:
a) If the carry back period is 3 years, what is the firm's marginal

explicit tax rate in the current period? b) If the carry back period is
2 years, what is the firm's marginal explicit tax rate in the current
period?
c) Suppose the carry back period is 2 years and taxable income in
period -1 was only $1 million. What is the firm's marginal
explicit tax rate in the current period [taken from Scholes et al.
2002: 177]
6. Statutory corporate tax rate in 2017 is 25%. From 2019 the

tax rate is 70% probable to be 23% and another 30%
probable of being 22%. Discount rate is 9% and will prevail.
Assume an extra income of TKI.OO looses an exemption of

TKO.IO permanently and another loss of exemption of

TKO.40 for 5 years. You also invested in two projects, one
fully taxable giving a return of 12%, another partly taxable or
tax favored with a return of 11%, and the other totally tax
free with a return of 10%. Further suppose next year every
one taka increase in depreciation results an accounting
depreciation of TKO.02 and tax purpose depreciation of
TKO.OI, and an increase of perquisites results an accounting
perquisites of TKO.004 and tax purpose perquisites
ofTK0.003.
Required
a) What will be the marginal tax rate in 2018?

b) Calculate marginal tax rate in 2019?

Taxation of Multinational
Companies
Objectives:
Worldwide vs. territorial tax
Tax credit
Transfer price
Arms' length price
Debt financing, royalty, head quarter overhead
CFC
POEM
Multinational companies have business in

more than one country and face different taxation system.
Tax structure is different for example, one corporate
income tax in one country but different corporate tax rates
for different businesses in another country. UK has one
corporate tax rate for all businesses whereas Bangladesh
has six to seven corporate tax rates for different
businesses. In Europe customs duties are almost zero
whereas a multinational company (MNC) in Bangladesh
has to pay customs duties for its import. In Bangladesh
corporate tax rates are historically higher than personal
tax rates whereas, in most of the countries personal income
tax rates are higher than corporate tax rates. Why are tax
rates different? The simple answer is many governments
try to attract foreign investment for reasons like installing
higher technology, increasing exports, and increasing
employment, Because of the variations in tax laws between
countries, MNCs have more scopes to utilize creative tax
strategies one of these is shifting corporate income from high
tax country to IOW tax counfry. The advantages of investing
in foreign countries for a MNC depend on many factors, tax

and nontax factors. Pretax rate Of return on investments

abroad can differ from that available
domestically. A higher after tax rate of return
abroad is a condition for investing and
reinvesting abroad. Importantly, after-tax
accumulations require considering not only the
current taxes but also potential taxes in future.
Secondly, a MNC can use higher transfer price
and thus repatriate capital through this transfcr
price. It seems likely that this problem is more
severe in developing countries as many of
these countries lack sophisticated policies
dircctcd at stopping tax avoidance, such as
controlled foreign corporation rules and
transfer pricing regulations. In developing
economies, profit-shifting activities could also
be driven by the desire to hcdgc the company
against political risks such as expropriation,
and to protect the company from government
or state failure.
Territorial versus Worldwide Tax

Countries which have higher corporate tax
rates usually follow worldwide tax system,
that is, will tax domestic income and foreign
Income but after giving tax credit. Some
countries however, follow territorial tax
system taxing income earned only within the
country. These countries have a tax treaty
under which businesses will pay tax only in
the parent country. Another tax system is
hybrid-worldwide system where a country
may have worldwide tax with some countries
and territorial tax with others. Which system a

countlY should follow depends on many

factors. For example, Bangladesh has less
competitive advantage compared to other
countries so it has tax treaties with most of the
countries with FDI in Bangladesh. Second, a
country has a motivation to do tax treaty
because host country has a higher tax rate than
the guest country, for example, Hong Kong
with corporate tax rate of 16.5% has a
motivation to do tax treaty with Bangladesh
with 25% to 45% corporate tax rate under
which Cathy Pacific, the Hong Kong Airlines
pays no tax in Bangladesh but pays only in
Hong Kong.
Foreign Tax Credit

A MNC has a motivation to invest in a country
where tax rate is lower compared to the parent
country. If a MNC has to pay tax in both the
Taxation
countries it is double taxation and there no reason

why it shall invest in a foreign counfry because it
suffers a competitive disadvantage with its competitors
in the parent country. In order to overcome this double
taxation a country may do tax treaty so that MNCs pay
tax only in the home country or there is provision for
deduction of tax paid in the host counfiy, So countries
with the worldwide tax system give foreign tax credits
for taxes paid in the host countries. Tax credit cannot
exceed the parent company tax rate. For many years
tax policy in the US as well as the UK used variants of
the foreign tax credit system, Other countries like
Germany and France, however, chose to exempt
foreign source income fully or almost fully from

domestic taxation. But in one of the most striking

trends in corporate taxation in recent years, there has
been a significant switch to exempting foreign-source
income from taxation. According to PwC Worldwide
Tax Summaries, out of 37 high-income countries, 19
had an exemption system in 1998, rising to 27 in 2008.
None of these 37 countries switched from exemption to
a credit or other system during this period. These
countries with territorial tax system have lower
corporate tax rates than countries with worldwide tax
system.
This trend appears to conflict with two key
results in the classical theory of international taxation. The first
result states that countries should tax the foreign source income
of multinational firms according to the foreign tax credit system
to make sure that the allocation of capital in the world economy
is undistorted (Richman 1963), This result is based on the idea
that, under the foreign tax credit system, I firms will
ultimately pay the same tax, irrespective of the investment
location, so that their location choices are not distorted if
corporate tax rates differ across countries, achieving so-called
capital export neutrality (CEN). However, the US offers a
gigantic loophole: after paying each country's taxes, the
additional US tax on US multinationals' foreign affiliate
profits can be deferred indefinitely (perhaps forever) by the
simple expedient of not remitting those profits back to the US.
Instead, the funds are parked in tax havens, such as Bermuda, or
are reinvested in other foreign operations. The accumulated, but
un-repatriated, profits of American multinationalS'
foreign subsidiaries—which have legally escaped
US taxation are estimated between $2,1 and $3
trillion.
Tax in the parent country = foreign

income (tp — th) where tp is tax rate of

parent country and th is the tax rate of

host country
Example
XYZ cement (pvt) of Bangladesh has a

subsidiary in UK. Income before tax in the
subsidiary BPS500 million, corporate income
tax in UK 21%, and 35% in Bangladesh,
dividend declared 40% of after tax income,
withholding tax from dividend 10%.
(i)When XYZ owns controlling interest say

60%, XYZ follows equity method where
investment is debited and income is credited,
and when dividend is declared, dividend
receivable is debited and investment is credited.
income = 500 X = BPS300 income
tax = 300 x (tp - th) = 300 X (0.35 -
BPS42
(ii) When XYZ owns non-controlling
ownership say 20%, corporate income is not
shown rather dividend declared is treated as
income dividend income = 500 (l th) x 0.40 x
0.6 = 500 x (1-0.21) x 0.4 x 0.6
= BPS31.6
Tax payable = 31.6 (0.35 -0.21)
= BPS4.42
Debt Financing and Profit Shifting

Intra company loans to affiliates in developing
countries respond more to tax rate changes than
loans to affiliates in developed countries. If a
developing country increases its tax rate the
increase in debt financing of local affiliates of
multinational firms is on average twice as large as
the increase in debt financing that would occur in
a developed country, as a result of the same tax

rate increase. At the same time, the decline in debt

financing in response to tax rate cuts is also larger
(Fuest et al. 2011). MNCs can charge higher
interest rates among its affiliates with
Taxation
higher corporate tax rates and get higher tax

savings. Bangladesh Income Tax Ordinance
1984 has no restriction on the deductibility of
interest.
Royalty Payments
MNCs are technology-intensive, and most value
resides in their proprietary technologies or
intangible assets. Even if research and
development (R&D) costs have been incurred by
home country of the MNC, current rules allow
the transfer of the patents or brands to a holding
company or subsidiary (in a low-tax country
which then charges royalties to headquarters and
other affiliates (Dischinger & Riedel, 2008).
Most governments allow deductions for royalty
payments, which reduces tax liability to the
licensee—even if the licensee is part of the same
MNC, and even if no R&D had been performed
in the licensee's nation,
Example 1
Suppose BAT (BD) paid TKIO million royalty to
its parent company in UK and earned a profit
before tax of TKIOOO million. Income Tax
Ordinance u/s 30 (h) allows 8% of profit before
tax as admissible expense. How much profit
BAT (BD) has shifted to UK? Remember
corporate tax rate for tobacco business is 45%.

Solution
Profit shifted = TKIOOO x 0.08 x 0.45 = TK36 million
Other Central MNC/Parent Overheads and

Costs
Research and development and other categories
of overheads, such as the costs of maintaining
brand equity, and other central administrative
costs at headquarters, such as global information
technology, supplychain management, human
resources, etc., incurred by the parent firm and
allocated among its cost affiliates. are
usuallyMNCs have motivation to allocate a larger
slice of the overheads pie to operations in higher-
tax nations.
Grossing up
Gross dividend received from the host countlY =
net disidend withholding tax rate
Gross corporate income in host

country = net income /
Branch versus Subsidiary

Income from foreign branches is taxed in the
hotne (parent) country as it is earned. But income
of subsidiaries is generally deferred from home
country taxation until it is repatriated.
Transfer Price
Transfer price is the price charged by one
segment of an organization for a product or
service that it supplies to another segment of the
same organization. The literature on transfer

pricing in a single country setting focuses on goal

congruence behavioral effects and autonomy.
Transfer pricing problem in multinational
companies is coupled ith additional dimensions.
MNCs avoid corporate tax by overpricing
imports. Overpricing imports mean (i) foreign
currency transferred abroad, (ii) cost of goods
sold is higher and profit understated, and
consequently paying lower taxes. Further in
Bangladesh, pnce of pharmaceutical products of
products are regulated by the government.
Section I l of the Drug (Control) Ordinance 1982
precisely states that the government shall fix the
maximum price at which any medicine will be
sold (Chowdhury 2089)
Cost of raw material +
certain mark up
In such situations, firms both domestic and
multinationals "'till try to overstate the CIF price to
get high mark up and selling price and higher profit.
Although there is a risk of higher customs duties for
imported raw materials, it is not always relevant for
many products as there are no or little duties. In
most of the cases, the net benefit of overpricing is
higher than costs Involved. The transfer pricing
problem In multinational enterprises is more
complicated than in domestic
T
Qxation
enterprises because MNCs are exposed to

additional environments considerations.
Choi (1978) states "variables such as
differential taxes tariffs, competition,
inflation rates, currency values, restriction

on fund transfer and political risks

complicate transfer pricing.
Arms Length Price

Host country governments sometimes can
restrict this overpricing behavior. Arms length
price is one. It is thc price prevailing in the
market between independent buyers and sellers.
It is an Unrelated or unaffiliated price where the
buyer and the seller are unrelated or unaffiliated
and consequently the price is based on market
forces rather than influenced and controlled by
any relation or affiliation, In the developing
countries government authorities could not
effectively apply this mechanism of controlling
overpricing as MNCs can exercise some power
on the host country government and its
bureaucrats (Chowdhury1989).
Nontax Factors
There are nontax factors that affect the
decision to locate production abroad. These
include the size of a foreign market, its
growth prospects, wage and productivity
levels abroad, the foreign regulatory and
legal environment, and distance from the
home country
CFC Rules
With increase in globalization, geographical

boundaries of countries have become blurred
and many multinational groups try to get
benefit of their global presence to minimize
their overall tax costs by using low tax

jurisdictions for tax planning. One of such

measures used by multinational goups is to
park profits in no or low tax countries without
actually bringing such profits to ultimate
parent company located in relatively higher
tax jurisdiction. This practice sometimes
results in substantial/ perpetual deferral of tax
Payments on such profits. Controlled Foreign
Corporation (CFC) Rules aim at taxation Of
such profits, which are parked in foreign
companies in low or no tax jurisdictions, in the
parent company's home jurisdiction. CFC Rules not
only help in taxation of profits in the residence
country of ultimate parent, to which such profits
actually belong to, but such rules also have positive
effects in source countries because taxpayers have
no (or much less of an) incentive to shift profits
into a third, low-tax jurisdiction.
CFC Riles are generally meant to counter

propensity on the part of MNCs to defer taxes
through parking of passive incomes (e.g.
royalties, fees, interests, capital gains, profits
made from buying and selling products from
and to related parties, etc.) at the level of
foreign subsidiaries, instead of repatriating the
same back as dividends. For UK, a foreign
company is a CFC if it's a non-resident UK
company that's controlled by a UK resident
person or persons. OECD has framed CFC rule
regarding (i) deterrent effect; (ii) interaction
with transfer-pricing rules; (iii) effectively
preventing avoidance while reducing
administrative and compliance burdens; and
(iv) avoiding double taxation. Any profits
diverted from the UK that will then be
apportioned and charged on the relevant UK

corporate interestholders. There are also a

number of entity level exemptions to reflect the
fact that the majority of CFCs are set up for
genuine commercial reasons.
CFC Rules in India

In India, concept of CFC was first introduced
to Indian taxation regime as part of proposed
Direct Tax Code, 2010, which was retained in
revised draft of Direct Tax Code, 2013. As per
CFC Rules introduced in Direct Tax Code,
profits earned by a Controlled Foreign
Company, located in territory with a lower rate
of taxation, will be included in taxable profits
of parent company located in India. For this
purpose, Controlled Foreign Company shall be
a company (a) which is a resident of a territory
with lower rate of taxation, (b) shares Of which
are not traded on any recognized stock
exchange in such territory, (c) which is
controlled by Indian residents, individually or
collectively, and (d) which is not engaged in
active trade or business
Taxation
and more than 25% of whose income comes from

passive sources such as dividend, interest, capital
gains, income from house property royalty, annuity
payments, etc. Further, appropriate provisions have
been made in Direct Tax Code to ensure that profits of
CFC, which are taxed in hands of parent company
once, are not taxed again when such profits are
actually repatriated in form of dividend by CFC to
parent company. However, Direct Tax Code is yet to
become law in India and presently there are no

statutory provisions in existing Income Tax Act for

enactment of CFC Rules.
CFC Rules vs, POEM under Indian Income tax law

Under existing Income tax Act, the Government has
recently introduced concept of Place of Effective
Management (POEM). As per POEM, even a foreign
company can be said to be resident in India and its
global income can be subject to tax in India, if place of
its effective management is held to be in India. POEM
has been further defined as a place where key
management and commercial decisions are necessary for
conduct of business of an entity. Statutory Guidelines by
Government of India for determination of POEM have
been issued recently in 2017. POEM gives a wide power
to Indian tax authorities to allege that all foreign
companies, whose parent company is an Indian company
and key business decisions are taken by promoters and
directors located in India, be treated as Indian resident
and their global income be taxed in India,
irrespective of: (i) whether such foreign
company is located in a tax haven territory
of lower taxation or not; (ii) whether such
foreign company is formed for bonafide
global business expansion of Indian
multinationals or merely for treaty abuse
and parking global profits in low tax
jurisdictions outside India.
The wide concept of POEM and its

potential of being misused for unnecessary
harassment and litigation by tax authorities
can be a big deterrent for Indian
multinationals from setting up genuine businesS
operations outside India. POEM is also be seen as a

threat by foreign companies, executing large projects in

India through project offices, especially in oil & gas and
infrastructure sector or having majority Of
their global business operations in India or
those having other forms ol' permanent
establishment in India, as Indian tax authorities
may allege these foreign companies to be
residents in India and tax their global income in
India.
Questions
l . Differentiate between worldwide tax

system and territorial tax system.
2. Why does a country follow worldwide
and another country territorial tax
policy?
2. What is the possible problem of
worldwide tax system?
3. How is the problem of worldwide tax
system addressed?
4. What is a tax treaty? How does it
address double taxation problem?
4. Can there be a uniform tax law around
the world? Explain.
5. Can citizens avoid paying taxes by
living and working abroad?
6. What are the differences between a
MNC operating as a foreign branch and
a foreign subsidiary?
7. Are there any restrictions on foreign tax
credit? Why they exist?
8. Do lower tax rates in host countries
imply higher after tax returns in host

country compared to parent country?

Explain.
9. What is transfer price? How is it related
to MNCs?
10. Why do MNCs in Bangladesh have
motivations for higher transfer price?
Explain.
I l. Why MNCs do not raise capital from
host country stock market?
12, What is CFC? What is its purpose?
13. What is POEM? What is its purpose?
What is its threat?
12. What tax policy Bangladesh
government should adopt to counter
tax avoidance strategy of a MNC with
regard to royalty, interest, and head
quarter overhead expenditure?
Taxation
Exercises
1. XYZ Co. Ltd. is a Bangladeshi
company also does business in India
and Nepal. It has pretax income of
TK45 million in 2013. It owns 68%
of its Indian subsidiary which
reported pretax income of TK30
million in the same year. XYZ
directly owns its Nepal operations,
considered as a branch which
recorded pretax income of TK18
million in the year. Assume all
earnings are reinvested in the
country where they were earned.

Corporate tax rates are 27.5% in

Bangladesh, 29% in India, in Nepal.
What is XYZ's 2013 Bangladesh tax
liability after foreign tax credits?
2. ABC Pharmaceuticals is a multination company in

Bangladesh. Recently, the
company has imported
some pharmaceuticals
from its parent company in
US. The details are as
follows:
Antisera $6000, Therapeutic
glands $10000, Bandages $
8000.1nsurance costs and
freight-in are $5000 and $3000
respectively. For simplicity,
assume that all the above
products are subject to customs
duty 12% and VAT 15%. The
collector of customs knew that
MNCs sometimes over-invoice
their imports particularly when
they import from their parent
companies. So he collected
prices from independent
sources as such:
India World average

Antisera $2500 $4000
Therapeutic glands 4800 6200
Bandages 5000 5500
Required: (i) The value for

assessable value, (ii) customs duty,
Oil) duty paid value, (iv) VAT. Compute these values

according to bill Of entry and arms' length price, (v)

corporation tax benefit assuming corporate tax rate of
28% and 50%. The exchange rate is $1 = Tk 78'
Wealth Tax 18
Chapter objectives: Double taxation

Tax on stock
Repeal of wealth tax
Alternatives to wealth tax
Modified wealth-income tax

Wealth tax was introduced by the Wealth Tax Act 1963 with the
intention of discouraging concentration of wealth. It continued till
1998. The tax was assessed on progressive rates such as
First 5 lacs of net wealth @ nil

next 5 lacs @0.5% next 5 lacs
@0.75% next 5 lacs next 5 lacs
@1.25% next 5 lacs @1.5%
next 5 @lacs 2% and the rest net
wealth @2.5%.
Exemptions
The assets which are excluded from wealth tax are copyrights, land up
to TK1m, one dwelling house, agricultural equipments, tools and
instruments to carry out business and profession (maximum
Taxation
222
TK20000), foreign currency account in a bank in Bangladesh

us
e government savings certificates, furniture for household investment
up to TKO.2 m, insurance policy, pension and provident fund,
immovable property of chambers and trade associations, any award
from the government, The assets are valued at cost. If a

business incurs loss in any year and did not pay dividend, then wealth
tax is not applicable in that year.
Example 1
Mr. Latifur Rahman has the following information for the income year
2014-15. (A) Agricultural income TK20 million, income from
business TK45 m, income from house property T1<30 m, capital
gain TK65 m, dividend income after 10% TDS TK15 m,
salary income as
CEO TK8 m, speculation business loss TK 36 m, (B) agricultural
land TK70 m, house property TK260 m, one apartment for his
residence TK32 m, agricultural equipments TK25 m, deposit in a
foreign currency account with Standard Chartered Bank, Dhaka $5
m, government savings certificates TK3 m, post office fixed deposit
TK3 m, jewelry TK50 m, household furniture TK2 m, investment
TK80 m, insurance policy, pension, provident fund TK75 m, tools
and instruments to carry on his business TK40 m, motor vehicles
3000 cc, TK15 m, cash at hand TKI m, cash at bank TK3 m, bank
loan TKIOO
m. (c) household expenditure on food, accommodation etc., TK30
m, spent TK2 m for his brother, TK3 m for spouse. (D) interest on
government savings certificates and post office deposit TKO.6 m
after TDS 10% (final settlement u/s 82 c), interest on bank savings
account TKO.3 after TDS 10% . (E) advance income tax during
fitness of motor vehicle TKO.05 m.
Requirements: (l) income tax payable, (2) wealth tax according to

the Wealth Tax Act 1963, (3) ser charge,(4) difference between
wealth tax and ser charge.
Solution
l.lncome Tax:

Agricultural income
TK20 million
Income from business 45
Income from house property 30
Income from dividend 15/0.9 16.67m
Less exemptions 0.025 16.6
Salary income as CEO
8
Interest on securities 0.6/0.9 0.67
Interest on bank savings account 0.3/0.9 0.33
Income chargeable at ordinary rates 75.6
Income tax:
First TK250000 nil
Next TKO.4 0.04
Next TKO.5 0.075
Next 0.6 m@20% 0.12
Next TK3 0.75
Rest 70.85 or (75.6-4.75) 21.25
Add capital gain tax @15% of TK65m 9.75
Total income tax 31.98
Total income 75.6+65
Less (1) tax credit on investment allowance@15% on the lower of
(i) actual investment of TK80 m,
(ii) 25% of total income of 140.6m, and (iii) TK25m
(3.75)
(2) TDS 0.067+ 0.03 (0.1)
Net income tax payable 28.14m
2. Wealth tax
Agricultural land TK70 m
Less exemptions (1)
69

T
224
QXQti01t
House property 260

Residence apartment +32
Less exemption (32)
O
+25
Agricultural equipments
Less exemptions (25)
0 Foreign
currency account in Standard Chartered Bank 5 Less exemptions
0
Government savings certificates 3
Less exemptions (3)
Post office fixed deposit 3

Jewelry 50
Household furniture 2
Less exemptions (2)
Investments 80
Insurance policy, pension, and provident fund 75
Tools and instruments to carry out business 40

Motor vehicle 15
Cash
Cash at bank
3
Total assets
481
Less bank loan
(100)

Net wealth 381

Wealth tax:
First TK2.5 m
nil
Next TKO.5 m TK2500
Next TKO.5 m 5000
-Next TKO.5 m@1.5 0/0 7500
Next TKO.5 10000
Balance (TK381m-4.5 m 9.41 m
Total wealth tax 9.43 m
Less TDS motor vehicle wealth tax (0.02)
Net wealth tax 9.41m
3. Net wealth without any exemptions = assets - liabilities = 664

100 = 564m
Surcharge on
TK28.14= 8.44 m
Repeal of wealth Tax

Wealth tax has been repealed since 1991. Now a surcharge system is in
place for wealth exceeding TK25 million. A surcharge of 10% to 30%
is imposed on the net income tax assessed (10% of income tax for net
wealth >TK25m<TK50m, 15% for net wealth
20% for net wealth>TK150<TK200m, and 30% for net wealth
>TK200m), Wealth tax has become unpopular because it amounts to
double taxation. Wealth is a the accumulated income on which income
tax has been paid and tax again on that accumulated income (wealth) is
a double taxation. Secondly, it is a tax on stock. Tax is better charged
on flow rather than stock. If that stock generates flow that is income
that income is subject to tax, That is why many countries have repealed
this unpopular wealth tax.

Abolishing Wealth Tax around the World

In the past two decades annual taxes on wealth have been largely
abandoned across Europe. Austria, Denmark and Germany abandoned
them in 1997, Finland, Iceland and Luxembourg in 2006, Sweden in
Taxation
226
2007 and Spain in 2008. There are alternatives to wealth tax such
inheritance tax, gift tax and income from house property, and capital
gain tax.
Origin of Wealth Tax (why then there was wealth tax?)

The period 1974-9 saw a significant change in the political and
economic climate. In 1976 the Labour Government had to call on the
International Monetary Fund to rescue it from a major run on the
pound. An unsustainable level of inflation was linked to public
expenditure growth unmatched by likely revenue. The steady expansion
of social spending that had taken place since the Second World War
was checked. Trade union power reached its peak in 1974. Over half of
the employed population was members of trade unions. By 2010 the
comparable figure was just over a quarter and only15 per cent in the
private sector. Unions were powerful not just within particular
industries but had the capacity to shape economic policy, Provoking a
recession to check wage inflation was still seen as an unacceptable
strategy, so negotiation and compromise with the trade union
movement were deemed a necessary strategy by both major parties.
The National Union of Miners engaged in a battle against the
government's wages policy that resulted in a three day working week
and electoral defeat for the Conservative Government in February
1974. Inflation was to rise by more than 20 per cent and wages by more
than a quarter during 1974-5. To win trade union agreement to some
kind of wage restraint the Labour Party agreed, before the election, to
introduce a range of measures that would 'fundamentally redistribute
income and wealth'. Social policy legislation was to include increases
in pensions, a new child benefit, reductions in public housing rents and
a new annual tax on wealth (Glennerster 2012).

Alternative to Wealth Tax: Modified Wealth-Income Tax

Wealth tax is unpopular because it was imposed on stock of net
wealth. 0.5% to 2.5% of fair market value of net wealth (after some
exemptions) was the typical wealth tax rate around the world. Popular
taxes are imposed not on stock but on its flow or income. Also, wealth
tax may encourage capital flight. Therefore, this tax has been repealed
in most countries around the world (Bangladesh, India, UK, Germany,
Sweden, Denmark, Netherlands, reintroduced in Spain in 2012).
Those who propose wealth tax do it for reducing increasing inequality
around the world (Pickety 2015, Stiglitz 2015). They argue that most
of the inequality comes due to growth in rent (land) and rent arising
from the monopoly power and political influence. Inequality increases
when r, the rate return on capital is greater than the rate of growth of
the economy. If those at the top save their income, their wealth grows
farther than income as a whole, and so too their income (if r does not
diminish). Increase in the wealth-income ratio is essentially an
increase in the capital-income ratio—capital deepening. And this
inequality becomes acute when wages are low particularly in the
developing countries. Karabarbounis and Neiman (2013) reveal that
the share of labor in income in the developed world has fallen while
the share of capital in the total income has risen. Rise in capital
income and reduction in the labor income can account for much of the
change in the income distribution in Germany (Bartels and Jenderny
2014). The view that recurrent taxes on immovable property as
opposed to transaction based property taxes can be an important
growth-friendly source of government revenue. But Hansson (2010)
found that wealth tax dampen economic growth; 1% increase in
wealth tax rate decrease economic growth by 0.02% to 0.04% in 20
OECD countries during 1980-99. Stein (2014) however, found little
empirical evidence that low tax rates on capital gains and dividends
are correlated with higher economic growth. He shows that most of
the benefits of lower taxes on dividends and capital gains go to the
highest quintile of the income distribution. Looney and Moore (2015)
shows that there has been substantial decline in capital gain tax rates,
from 28% in 1989 to 15% in 2012, and the large share of unrealized
capital gains in the portfolios of households at the top of the wealth
distribution. Households at the top of the wealth distribution hold
assets in tax-deferred retirement accounts, financial assets, and real

estate. They suggest that unrealized capital gains be taxed at ordinary

Income tax rates.
Taxation
228
To remove this problem of stock and flow, there can be a 'modified

wealth-income tax'. Here, the sum of wealth tax and regular income tax
shall not be higher than a certain percentage of regular income, say 40%
of regular income or higher marginal tax rate in line with the developed
and developing countries. This method takes into aCCount both stock of
wealth and flow of income. This method will also raise more revenue
than currently received surcharge. Suppose, income is TKIOO, top
marginal tax will be 30% or TK30 and top surcharge of 30% of tax will
be TK9. But modified income-wealth tax will be maximum 40% of
TKIOO or TK40.
Questions
1 .Why is wealth tax repealed?

2. Is ser charge a form of wealth tax? How is it different from wealth
tax?
3. Government is planning to reintroduce wealth tax. Comment on its
strengths and weaknesses of the plan.
4. What are the other alternatives of wealth tax?
5. Why then there was wealth tax in early seventies?
Exercise
1. Determine' wealth tax for Mr. X from the following information

according to the Wealth Tax Act 1963
Mr. X has personal assets TK3 million. His sole ownership business
assets TK2.5m and liabilities are TK1m. His share in partnership is
1/3rd, assets TK6m less liabilities TK2m. Investment in DSE shares is
TK3.5m. Award from the government is TKI .2m. his scientific
instruments are worth TKO.8m.

Required (i) Why is wealth statement submitted together with income

tax return even though the wealth tax has been discontinued? (ii)
Determine wealth tax as per Wealth Tax Act 1963.
Corporate Tax 5
Objectives of the chapter:

Tax planning and strategy
General rule for admissible expense
Flaws in some provisions
Carry fórward and setoff of losses
Block assets and depreciation
Double taxation

Deferred tax
Executive remuneration
Provident fund contribution and trust fund
Share option
Transfer pricing
Income from business or profession covers the corporate

sector under sections 28, 29, and 30.Section 28 defines
income, section 29 allowable deductions from income of
business or profession, and section 30 deductions not
admissible in certain circumstances (or maximum ceiling for
certain expenses). Depreciation is allowed under the Third
Schedule. Definition of income (ws 28) as defined below is
faulty. This section separately explains income of life
insurance companies and oil and gas industry (28(2). There
are provisions deductions for expenses u/s 29 which (i) are
incurred for the business, (ii) transaction based on market,
(iii) and objectively estimated. Bad debts are allowed as
admissible deductions but provision for doubtful debts is not
allowed for the corporate sector except in banks. The sub
sections xviiia and xviiiaa provide for provision for doubtful
debts or classified loans which are faulty (explain in a
separate chapter on banks).
Advanced
Taxation 58
There are exemptions from tax of newly established physical

infrastructure (export processing zone, flyover, gas pipe line,
Hi-tech firm, ICT village and similar infrastftlcture) for ten
years at reduced rates of exemption, beginning 100% of
income in the first and second years and ending with 10% in
the tenth year (u/s 46C),
There are provisions for unrecoverable tax of private

companies (Il/s 100 in Chapter X. Liability in special cases).
When a private company is wound up and any incomc o of
any income year cannot be recovered, the every director shall
bc liable to pay the said tax jointly and severally.

General rule for Admissible Expense

The expenses and losses which are considered for allowable
deduction must fulfill the conditions (i) incurred for the
business; if an expense or part of it is used by any member
of the company is not an admissible expense; (ii) the
transaction is market-based; if any transaction involves an
expense higher than market because the transaction was
done between related parties then the excess expenditure is
not allowed as a deduction; (iii) objectively estimated, and
(iv) the transaction is transparent and disclosed in the books
of accounts.
Inconsistencies
There are certain inconsistencies in determining the
admissible expense for entertainment, foreign travel, head
office expense, and technical service fee (u/s 30 f, g, h, j,
k). These are tied to profit, that is, certain percentage of
profit except travelling expense which is tied to certain
percentage of turnover. Turnover is better than profit for
this purpose. Turnover is usually consistent and stable over
years but profit follows a zigzag road. Importantly, if a
business makes a loss then according to the rules there are
no allowable deductions for these expenses but this does
not make sense. Incentive bonus however is rightly related
to profit because bonus is paid only when there is good
amount of profit.
CamScanner
59
Tax Planning is Important

Companies apply tax planning and strategies because they
tax rates affect investment and financing decisions, Tax
holiday, effluent treatment plant or tobacco industry,

interest deductibility of debt capital, accelerated

depreciation, employee remuneration and benefits are some
areas where tax planning and strategy plays an important
role. Here tax authority is an investment partner rather than
a competitor. Shifting income from tax disfavored areas to
tax favored areas legally is a lot of strategy. A business
house always looks for maximum exemptions of income
and admissible expenses. There are always the risks of
frequent changes in the tax regime. Present value concept is
very relevant in starting a long term project and employee
remuneration, for example. Tax authority also applies
various strategies for discouraging tax avoiding and evading
behavior of taxpayers. Many countries including
Bangladesh uses arms' length price for restricting higher
transfer price or imported price. Tax planning and strategy
does not only consider tax issues but also nontax issues. For
example, fringe benefits like insurance policy may be good
for employees because it is tax free but employers may not
think it better than giving cash for it has to arrange some
extra administrative
burden.
Tax formula
Revenue
Less exemptions (xxx)
Gross income
Less allowable deductions (xxx)
Taxable income
Gross tax
Tax credit/rebate (xxx)
Tax payable

/ldvanccd T
The law defines business income as (a) profits and gains,

(b) incornc and None of the definitions are
correct, Profits and gairn tn (a) interchangeably used as
income. Income means income in does not make sense.
Perquisites or benefits in (c) are salary income of an
indisidual not of a business. The simple definition of
income from business is the difference of revenue and
expenses. Section 2S however, has a strength: it recognizes
the fact that income measurement in a multi-period
business like a life insurance business (2a) or an oil and gas
industry (2b) is different from that in a single period
business in (la and 1b).
Additional tax (16 B)

If a listed company does not pay cash or stock dividend, it
shall pay an additional tax of 5% of income before tax.
Even after this regulation companies rarely pay cash
dividend once in three years on average. Stock dividend
will not make much difference because it only increases
capital of shareholders. But turnover (value of sales of
shares) as a percentage of GDP is 6% only compared to
more than 25% even in neighbors. Thus stock dividend
does not change companies' behavior on payment of cash
dividend. Therefore this provision was deleted in
subsequent period.
Additional tax (16C)

If a banking company earns profit of more than 50% on

capital including reserves then it shall pay an additional tax of
15% of profit before tax. This law is faulty because (i) a
company should not earn that much of profit, (ii) return on
equity is not an appropriate measure of performance because
banks do not operate by equity capital but by customers'
deposit, (iii) even if banks earn that much
of profit it is a monopoly situation which is
the failure of the government. Therefore
this provision was omitted in subsequent
period.
Can-scanner
61
Minimum tax (16CCC)

A company with gross receipts ore than TK500 million has
to pay a minimum income tax of 0.3% of gross receipts even
if it makes a loss. This provision violates the basic principle
of taxation where income tax is paid on income. This
provision was probably enacted because of the fact that
companies have a tendency to show losses. However, one
mistake cannot be corrected by another mistake and
therefore the provision was discontinued in subsequent
period.
Premium on share issue (53L)

Once there was TDS of 3% on premium on issue of shares
and subsequently deleted. Premium is neither income from
business nor a capital gain rather a part of capital.
Therefore, tax on premium is not an appropriate provision.
However, there is no grave fault on this provision because
premium is a sort of capital gain as it represents reputation,

goodwill, performance, and incremental profit earning

capacity over the market or industry.
Transfer Price (107 F)

This section provides for a certificate by a chartered
accountant of the authenticity of transfer price of goods
imported. It gives monopoly to a particular class of
accountants. There are other groups of accountants such as
cost and management accountants (CMAs) and certified
accountants (ACCAs). It is often claimed that chartered
accountants had gone through practical experience and
therefore the law rightfully recognizes that. But it should
be noted that in most of the cases, CMAs and ACCAs
qualify while they are on the job. Rarely any student
qualifies without being on any job or practical experience.
Carry Forward and Setoff of Losses

Sections 37 to 42 of the Income Tax Act 1984 provide for
carry forward and setoff of losses. These are provisions
for allowing loss under any head in a year to carry
forward to six subsequent years

Corporate Tax
Advanced Taxation
62
against income of those years, But speculation loss and capital loss shall
be set off only against their respective incomes. Again loss from
business or profession cannot be set off against income from house
property.
Example
18, XYZ enterprise has the following income and losses during 201516:
interest on securities TK5000, income from house Property TK80000
(municipal value TK 90000), agricultural income TK40000 loss on tea
garden TK50000, income from business T1<50000 (sole
proprietorship), loss on speculative business T1<25000, capital loss
TK30000. Determine the total income of the business while considering
setoff and carry forward of losses u/s 37 to 42 of the
Income Tax Ordinance 1984. Total income
TK5000
TK90000
Solution
Total income, 2015-16: (27000)
Interest on securities 63000
40000 10000
Income from house property
Less repairs and maintenance (30000)
Agricultural income 50000 30000

Less loss on tea 60% (agriculture) of TK50000 (20000)
Income from business

Less loss on tea 40% (business) (25000)
Loss on speculative business to be carried (30000)

forward and set off from speculative gain 108000
Capital loss to be carried forward and
set off from capital gain next year
63

Corporate Tax
Depreciation (Third Schedule)
Depreciation is provided by the Third Schedule. There are rates
from 2% to 100% of the written down value depending upon
economic life, useful life, wear and tear, personal or business use,
environmentally friendly or not, innovation or import, single or
block asset, used first time or existing, using for life saving drugs,
and employment generation. NBR allows reducing balance or
written down value method (cost price less accumulated
depreciation) foi charging depreciation in general and straight line
method (on cost) in special cases. Text books of accounting
suggest the straight line method as the simplest method for
calculating depreciation. It is not true for some assets like similar
furniture and equipments. In straight line method, depreciation has
to be calculated for each of these assets separately if these are
purchased at different time and have different useful life. This
exercise takes time and need lots of information. However, some
assets for newly established industrial undertaking are allowed
accelerated depreciation and are based on Straight line method.
Effluent treatment plants and other environment friendly
equipments also get straight line method. (u/s 7, 7A, Third
Schedule). Ships which are less in number also allowed straight
line method. Cost of all assets except motor vehicles as shown in
the books of accounts, are accepted by NBR for determining WDV
and depreciation allowance but each motor vehicle is allowed a
maximum cost price of TIO million (u/s 6, Third Schedule). A
business can buy a luxury vehicle but NBR cannot allow luxury
for tax purpose.
Block Assets
Block assets are group of assets within a class of assets such as
e
quipment and furniture. One rate of depreciation is applied on all
furniture like chair and table. Similarly buses, lorries and taxies
can be put together as a block item and a single depreciation
applied. Written down value or book value of the block assets is
taken for calculating
Advanced Taxation

Corporate Tax
and just amount of depreciation for the block of
assets is charged to income statement. Unlike straight line

method method makes the calculation simple. In
Income Tax ordinance 1984, the Third Schedule, there
allowed four categories of block assets: building buildings,
office equipment, furniture and fittings plant and machinery,
and ships. There are subdivisions for different block of assets
and different rates of depreciation are used, for example,
10% depreciation for general buildings and 20% office and
factory buildings, 20% for motor vehicles not for hire and
24% for motor vehicles for hire.
Unabsorbed Depreciation
If the profits of a business are not sufficient to absorb the
depreciation allowance, the allowance can be set off against
the profits of any other business, or any other head. Any
depreciation allowance still unabsorbed can be carried
forward and set off against the profits of the business of the
following year.
Example
XYZ Ltd has the following information in its income statement

for the ending June 30, 2016. Sales revenue TK900 million, cost
of goods sold TK600m, operating expenses TK150m, dividend
income TK3m, income tax charged @25%. Scrutiny by NBR
reveals the following (i) closing stock was overvalued TKO.8m,
(ii) an old equipment was cost price being TK5m and WDV
TKTK3.8m, (iii) advance income tax paid TK24m, (iv)
operating expenses include depreciation
perquisites TKO.5m to each of its 15 directors, provision for
doubtful debts TKO.7m; NBR however allows depreciation of TK3m
as per the Third Schedule, (v) TDS on dividend 10%. Determine (i)

Corporate Tax
accountant's income and tax, (ii) NBR's income and tax, (iii) total
income and tax payable as per NBR.

Corporate Tax 65
Solution
(i)Accountant's income
Net profit before tax including net of capital gain as per books of accounts
TK155.2
Less income tax @25% on income excluding capital gain (155.2—
1.87)
38.33
Net income 116.87
(ii)NBR's income
Accountant's income 155.2
Add excess depreciation TKO.6
Excess perquisites (0.5 x 15) —(0.45 X 15) 0.75

Provision for doubtful debts 0.7
Less inventory overvalued (0.8)
Capital gain (1.87)
4.78
Net income before tax 150.42
Income tax @25% 37.60
(iii)Total income and tax payable

Income from business 150.42
Less tax @25% 37.6
Net income after tax 112.82
Capital gain (sale — cost) = (6-5) 1
Capital gain tax @15% 0.15 0.85
Net capital gain 1.87
Total tax payable = income tax + capital gain tax —TDS —AIT
= 37.6 + 0.85 - 0.33 - 24 = TK14.12 million
Executive Remuneration
Managers are usually risk averse but shareholders are risk takers.
Also there is information asymmetry between managers and

Corporate Tax 66
owners in a public limited company, that is, they have more
information than
•tdvaneed ill T
66 and thetvq•ote they may not work for the shareholders,
ititetots,
RequitÈments:
(i) In such situations, what remuneration scheme should the

company adopt that pursue managers to take risk and work for
shnholdets' intenst?
(ii) What are their tax effects for both company and the executives?
Solution
(i) The company can give the employees shares. These are long
term incentive plans where the company's shares are given as
a part of remuneration. The benefits from shares come after a
long time usually 3 to 4 years. The executives have the
ownership now and therefore will take risk and work for
shareholders' interests.
(ii) The value of shares given is an admissible expense and the

employer gets tax benefit at the tax rate applicable for the
company. Employees pay tax at ordinary rates on the value of
shares received and capital gain tax on the capital gain which is
the difference between sale price and the value of shares on the
date of receipt.
Provident Fund and Gratuity Fund (First Schedule)

Any contribution to employees for provident fund and gratuity is an
allowable deduction from the company's income. There are conditions
however. Both the funds must be approved by NBR. These
contributions together with employees' contributions to provident fillld
must be funded by a board and the funds must be approved by the
NBR. Provident fund is contributory, that is ftnded by both employers
and employees and is invested for profit and interest. Gratuity fund on

Corporate Tax 67
the other hand is only the employer contribution. The frust shall apply
to NBR with the detailed rules of the ftnds. The rules
must include particulars of the trustee board, amount of employer and

employee contribution, investment of the fund, qualifications for
participating in the fund, and the provisions for receiving the benefits
after retirement or any time before retirement.
Example
A public limited company has a contributory provident fund system
which deducts 10% of employees' basic pay and the employer
contributes the equal sum. The basic pay of the employees is TK200
million. The First Schedule allows the employer's contribution as
admissible expense subject to conditions (i) there has to be a trust
managing the fund, (ii) there has to be framed rules for the investment
and distribution of the fund, and (iii) the requirements for employees to
receive the benefits,
Requirements: (i) what is the fund for the current year? (ii) What is the
tax savings for the company? (iii) what will be the fund after 5 years at I
| (iv) What is a trust and why it is important?
Solution
(i)Fund for the current year = TK200 x x 2 =TK40 m
(ii) Tax Savings for the company = TK200 X x 0.25= TK5m
(iii) Fundt5= Fundto (1 + r) k 40 (1.11)5
= TK67 million
(iv) A trust is a group of persons independent of the company for

managing the fund so that fund is not misused by the company
and employees get maximum benefit.
Is Corporate Tax Subject to Double Taxation?

The answer is yes and no. In general yes because companies pay
corporate tax and shareholders pay personal income tax when they
receive dividend income. Small shareholders particularly individual
shareholders do not suffer always because dividend income is exempt

Advanced
TK25000 year, Institutional shareholders however have to pay because

they have higher income from dividend. But they do not hay to tax on
dividend when company docs not declare dividend rather retain the
profit and reinvest, A company can also distribute profits in tax
deductible via interest, rent, royalty, remuneration. Again capital gains at
the shareholder level are taxed at reduced rates in many countries and in
Bangladesh only at 5% to 10% (u/s 53M and 54 ofthe Income Tax
Ordinance 1984).
Corporate Tax Exemptions Need Reform

Dhaka Stock Exchange and Chittagong Stock Exchange are
exempted from income tax at 20% to 100% for a period of five
years. Stock exchanges arc same as other public limited companies
and owned by industrialists, Garments industries used to pay income
tax at 10% of their profit but 2014-15 Finance Ordinance provides
tax at just 0.3% of export values at source and that is considered
final settlement requiring no further tax on profit (u/s 53BB and
82C). These are some reasons why Bangladesh has one of the lowest
tax-GDP ratio in the world.
Question
l . Explain critically the definition of income from business u/s

28 of IT ordinance 1984.
2. In Bangladesh corporate tax rates were historically higher
than individual personal tax rates whereas in most other
countries the opposite is true, that is, corporate tax rates were
lower than personal income tax rates. Explain the difference.
3, What is the impact on taxable income if some expense is allowed as an
admissible expense and not allowing it as an admissible expense
but allowing it for tax rebate?
4. Evaluate 16 B of the Income Tax Ordinance 1984: undistributed
profit of a listed company.

Corporate Tax 69
5, Evaluate 16 C of the Income Tax Ordinance 1984: Excess profit tax of
a banking company.
6. Evaluate 107 F of the Income Tax Ordinance 1984: Furnish a
reportfrom a chartered accountant.
7. Compare our top personal income tax rate and corporate income tax
rate with those of our neighbors.
8. Explain the theory why top personal income tax is higher than
corporate income tax around the world.
9. Critically compare our corporate tax structure with others.
10. Critically compare our tax law of provision for doubtful loans in banks
with that of other countries.
Il. Why corporate income tax is 40% in publicly listed insurance companies
when it is 25% for other listed companies?
12. Even though our corporate income tax rate was historically
higher than others why is this tax to GDP ratio is around 2%
compared to more than 3% in other countries?
13. Critically explain the definition of income under 2(34) and 28(1) of
the Income Tax Ordinance •1984.
14. The Third Schedule of the Income Tax Ordinance 1984 allows
depreciation @ 2% (i.e.50 years useful life) of written down value
of long lived assets like roads, bridges, and flyover but @ 10% (i.e.
10 years useful life) on building although useful life normally
exceeds 50 years. What is the rationality for this?
15. What is unabsorbed depreciation and what is the relevant provision
of the Income Tax Ordinance?
16. The concept of double taxation of public limited companies is
misleading. Do you agree? Explain.
17. Do income tax rates vary among various organizational forms
according to our tax laws? Give an account of this variation.
18. Explain when a Chartered Accountant acts as a 'Principal' and when
as an 'Agent' to his tax client. Which position is riskier?
19. In UK and some other countries, business income is taxed at slab
rates (i.e. more than one and progressive tax rates. Also remember
that salary income is taxed at slab rates. Then explain why our tax
laws allow only flat rate (i.e. one single rate) on business income, T
70
axati0ä

Corporate Tax 70
20. Provide an example of a tax rule designed to motivate socially
desirable activity that also motivates transactions th reduce a
taxpayer's tax liabilities but serve no social purposeat
21. What are the sources and causes of complexity in our tax
system? Which, if any, of these causes are correctible?
22. Identify three tax characteristics that differ among alternative
savings vehicles in our country.
23. Personal income tax is progressive but corporate tax is a flat
rate. Explain why.
24. If managers are remunerated in part on the basis of a bonus
based on accounting profit they are likely to object to any tax
plans that reduce reported profit. Do you agree? What actions
could the firm take to mitigate this problem?
25. do countries encourage investment by offering tax
incentives such as investment tax credits or liberal
depreciation allowances? What alternative methods exist to
achieve the same goals? How would you judge whether tax
incentives were superior to the alternatives?
26. Section 29 xviiia of Income Tax Ordinance 1984 allows
provision for doubtful loans in development banks at 5%
on doubtful loans but 29 xviiiaa allows 1% on total loans
in commercial banks. Critically explain these provisions.
27. How might tax considerations conflict with financial reporting
considerations? Provide an example from the banking industry.
28. Briefly explain the set-off and carry forward provisions of our
Income Tax Ordinance 1984.
29. What are the tax benefits of a fringe benefit such as
employersupplied life and health insurance? What are
the nontax costs associated with such a program?
30. The Third Schedule, Income Tax Ordinance 1984 provides

yearly depreciation rates from 2% to 100% depending upon
assets. Give the reasons for such variations.

Corporate Tax 71
31. Accounting text books level straight line depreciation as the
simplest method. But Income Tax Ordinance 1984 allows WDV
method. Explain NBR's two logic: matching logic and practical
logic.
32. Section 29 of IT Ordinance 1984 allows head office expenses and
entertainment as a percentage of profit, What problem might arise
with this arrangement? Can you think of a better alternative?
Explain,
33, There are some exemptions of income tax for "0tne corporate
sectors. Mention those and explain whether these ate these
justified,
Exercise
l, X Ltd, has the following income statement for the year ended 30
June 2013:
Sales revenue 47600
Rent of godown 80000
Claim against loss of plant & machinery by fire from insurers
2000
Interest on company deposit 25000
Dividend 50000
51 15000
Opening stock of materials 40000

Less ending inventory of raw materials (25000)
Salary to employees 990000
Incentive bonus 300000
Excess perquisites 80000
Purchase of materials 2400000
Donation 90000
Interest on loan 320000
Other administrative expenses 247000
T
azation
72 13000

Corporate Tax 72
140000
Technical scrvice fees 12000
Travclling expense 8000
Municipal tax on godown
253000
Insurance premium on godown
65000
Directors' remuneration
Depreciation on plant & machinery 143000
Provision for tax 39000
Net income 5115000
Total
Additional information:
i. Claim was received against fire insurance taken for the plant
& machinery at cost TK420000, written down value
TK185000. The plant & machinery was destroyed in fire
was scrapped and disposed of at no consideration.
ii. Dividend received was net of tax.
iii. Salary includes TK20000 gratuity paid to employees during
the year on cessation of their employment. The company
does not have any separate gratuity fund.
iv. The entire materials were purchased from a firm in which
Managing Director of the company was a partner. The
market value ofthe materials purchased was TK2000000.
v. Donation includes TK50000 paid to Zakat Fund, TK20000
ICAB.
vi. Municipal tax on godown includes other tax of TK3000 not paid.
vii. Directors' remuneration includes board meeting attendanCe fee

of TK50000 on which no VAT has been deducted and deposited
to the government treasury.
viii. The rate of depreciation on plant and machinery is 15%
under the Third Schedule of Income Tax Ordinance 1984.
The down value of the asset brought forward on 1

Corporate Tax 73
July 2012 was TK160000. In addition a new machinery was
purchased for TK23333 during the year.
ix. The company issued 100000 shares of TKIO each at a

premium ofTK3 each during the year.
Required: Compute total income of X Ltd. for the assessment year 2013-
14 and tax liability [ICAB 2015].
2. Consider the following information for XYZ Co. Ltd.

i) July 2010, 3 categories of block assets: building TK300
million, accumulated depreciation TK160m, plant &
machinery TK400, accumulated depreciation TKI 80m,
furniture & fittings TK15m, accumulated depreciation TK5m,
12 motor vehicles depreciated for three years, cost TK70m and
accumulated depreciation TK45m. Depreciation as per Third
Schedule, Income Tax Ordinance 1984: building 10%, plant &
machinery 20%, furniture & fittings 10%, motor vehicles 20%.
ii) July 2011, the company bought a motor vehicle costing TK8
million, and a Bangladeshi made computer software TKI 0m.
iii) December 2012, the company installed an effluent treatment

plant TK6m. Also opened a pharmaceutical plant with an
investment ofTK500m in plant & machinery.
Required:
a. What is block assets? Why does the NBR allow depreciation by
WDV method instead of straight line method?
b. Calculate depreciation expense for accounting purpose
c. Calculate depreciation allowance under the Third Schedule for
Assessment the assessment year 2012-13.

Taxation
74
3. The income statement ofNahid public Ltd Company for the year ended June
30 is below
TKIOOOOOO
Gross income
Operating expenses 200000
Salary 50000
Depreciation 10000
Audit fees 15000
Insurance premium 30000
Advertisement 40000
Income tax provision 20000
Provision for bad debts 30000
Repairs
10000
Penalty 15000
Donation 120000
Rent 90000
General expense
(630000)
370000
Operating income
Other income:
Share premium 50000
Dividend income 60000
Gain on sale of furniture 10000
Discount received 30000
Interest on tax-free government securities 60000
210000
Net income 580000
Other information:
l. General expense includes TK50000 as preliminary expense'

(2) advertisement is made for five years, (3) salary includes
TK40000 as contribution to provident fund, (4)
depreciation admissible as per tax law TK40000.
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Corporate Tar 75
Required:
a. Determine total income of the business
b. Calculate tax liability as per tax law [DU 2015].
4. You are an income tax expert and workñg in Y Ltd. as a Ottux manager. The
company is engaged in the business of export of the goods manufactured by
itself. The bank through which export proceeds of Y Ltd. is received,
deducts tax at the specified rate from the total export proceeds in accordance
with the provisions of section 53BB of the Income Tax Ordinance 1984. The
export proceeds net of income tax deducted at source under section 53BB
received by Y Ltd. during the income year 2013-14 came to
TKIOOOOOOOO. Export income of Y Ltd. falls under the scope of section
82C of the ITO 1984. Generally the company does not have additional
income from export as referred to in section 82C (6) of the ordinance.
In the income year 2013-14, a warehouse owned by the company since

1/7/2013 was leased out to another company for a term of 3 years from
1/12013 at a monthly rent of TKIOOOOO with an advance rental
payment of TK900000 to be adjusted with monthly rental payments
over 3 years. Y Ltd received rent for the income year 2013-14 but no
tax was deducted at source from the rent paid by the lessee. Nor any
VAT was paid on the rent. The repair cost of TK 1500, municipal tax
of TKIOOOO and insurance premium of TKIOOO were paid for the
warehouse during the income year 2013-14.
The net profit before tax for the year as per the draft financial
statements for the income year came to TK3304000. The net profit as
per income tax comes to the same amount assuming no
penalty/liability (if any) for non-deduction of tax at source by the
tenant and for non-payment of VAT. There is a tax refundable of
TK150000 for the last assessment year 2013-14. The income
(including advance) from warehouse and its related expenses were
depositedþaid out in cash into!from an undisclosed bank account of Y
Ltd and have not been included in the draft financial statements. The
purchase money of TK50000000 (total accumulated undeclared
T
76 axation
income of Y Ltd over the last assessment years) for the warehouse
was also paid from the same bank account.
The management of Y Ltd is thinking of assessment of income of

the company for the income year 2013-14 under section 82C of
the ordinance upon considering the tax collected at source by the
bank from the export proceeds as final discharge of tax liability,
In meeting with the management team of Y Ltd on tax issues, you
have been asked to consider whether it is possible to ignore
income from house property so that no demand for additional
income tax arises. To discuss the issue further, a meeting would
bc held next week.
Requirements:
i. Calculate the total income tax liability and further income tax
amount payable after adjustment of any amounts as per
income tax law. Assume that the undeclared income as above
ii. What will be the financial consequences for such nondeduction

and non-payment as per tax laws? [ICAB 205]

Capital Gain Tax 9
Chapter objectives:
Computation of capital gain
Transactions not considered transfer
Exemptions
Tax rates
Capital gain tax in India
Percentage deed value
Capital gain tax by size of property
Capital gain tax on shares
Capital gain tax is payable by an assessee on any profits and

gains arising from the transfer of capital assets. Capital asset
2(15) of the IT Ordinance 1984 means property of any kind
held by an assessee excluding consumable stores or raw
materials in his business, and personal effects like jewelry,
wearing apparel, furniture, vehicles which are held exclusively
for personal use and are not used by the business or profession.
Transactions not considered as transfer of capital assets

i. Gift
Any transfer of a capital asset by a company to its
subsidiaries iii. Any transfer of a capital asset by a
subsidiary to the holding company
Any transfer of a capital asset in a merger
Conversion of bond into equity vie
Conversion of partnerships into
companies
TQration
110
Computation of capital gains (L/S 32)

Value of the consideration — (cost price + improvements + selling
Tax rate (provision 2 of The Second Schedule)

For companies: 15% of capital gain
For individuals and partnership: ordinary rates subject to a
maximum
Exemptions u/s 32 (5)
Capital gain used for procuring another new asset for the
business or profession. In such a case no depreciation is
allowed
assetfor
and the when it is sold its cost and WDV will be
considered
is theentire sale price will be capital gain.
Sale or ffansfer of capital assets for setting up a new indusfry
and the capital gain is used as equity,
3. In India, there are instruments like capital gain bonds, in which

the profit arising from the sale of a property can be invested.
These have a lock-in period of three years and the maximum
limit for investing in such instruments is Rs 50 lakhs. These
bonds are currently being issued by NHAI and REC. If the
entire amount of long term capital gains is invested in these
bonds, the tax is fully exempted. Investments of any lesser
amount will grant a proportional deduction. The money can be
withdrawn after three years.
CapitalLoss
lossL scan
i
40 be set off and carried forward for six years
against
Capital Gain Tax in India

Cost inflation index is available in the Indian tax law (Lakhotia
1998: 172). Instead of 'cost of acquisition' 'indexed cost of
acquisition' is
Gaill Ill
used for computation of' capital gain. Likewitge, 'inclcxcd of

improvement' is calculated, The government ptil)lif'hctl inflation
index' from time to time, In Ireland, thc porchat;e price, cogt of
acquisition, and costs ol' improvement can bc adjusted for
inflation from 6 April 1974 up to 31 December 2()()2, and a table
is published by Revenue for the purpose of' calculating this
adjustment, The inflation adjustment can only operate to reduce a
gain; it cannot increase a loss or turn a gain into a loss,
Indexed cost of acquisition cost of acquisition x (cost
inflation index in current ycar/cost of inflation index in the
basc year)
Percentage of Decd Value

Since there is no provision for inflation index in our IT
Ordinance or Rules, acquisition cost is not used in
practice for computing capital gain. Rather 4% of decd
value or TK30()0() to TKI .08 million pcr I .65 decimal
area depending upon the location is taken for determining
capital gain on transfer of land and other establishments
(Rule 17-11). The higher of the two values is taken as the
capital gain, Capital gain is the sale proceeds of the asset
mentioned in the deed with the registration office and
capital gain tax is 4% of such gain (u/s 53 Il), and this is
the final settlement, that is, there will be no more capital
gain tax imposed on this asset at the time of final
assessment. Capital gain tax based on size of the
property, that is, the rates pcr 1.65 decimal area have not
been used so far bccause it is relatively difficult to hide
the size of the asset than the market price and the deed
value, Therefore the decd value is used and during 2012-
13, NBR collected TK10,28 billion as advance capital
gain tax (and also final settlement) which is 0.08% of
GDP. capital gain tax is 0.6% of GDP in other developing
countries and 2.1% of GDP in OECD countries (Slack
2013),
Capital Gain on Shares
In case of transfer of shares, capital gain tax of 5% to 10%

is charged on the difference between transfer value and cost
of acquisition (u/s
Taxa
tion 112
530) when the shareholder is an individual (u/s 53M, 530, 54) but
when the shareholder is a company the rate applicable to the company
(u/s54). The Principal Officer of a company holding Trading Right
Entitlement Certificate (TREC) shall collect this tax from the stock
exchange or the bank or merchant bank maintaining account of any investor
of shares. For sponsor shareholders and directors the rate is five percent to be
paid to the Securities and Exchange Commission (u/s 53 M). And for
shareholders of stock exchanges, the tax rate is 15% to be collected by the
Principal Officer of the exchange (u/s 53 N). There are however, other
provisions (u/s 64 (2) and Para 27 of part B of the 6th Schedule of the IT
Ordinance which are inconsistent with the above laws. It provides that
advance tax (TDS) will not be collected from 'agricultural income' and 'capital
gains'. Thus capital gain tax on shares is virtually exempt. Only TK54 million
(TK5.4 crores) were collected from the sponsor shareholders u/s 53M (NBR
Annual Report 2013-14). This is almost 0% of GDP whereas in UK capital
gain tax on shares was BPS3.32 billion which was 0.18% of GDP during
2015-16. In Indonesia, capital gain tax rate is 5% of sale proceeds, in Jamaica
it is 7.5%, in India it is 20% of the difference between sale price and
acquisition price adjusted for inflation.
Short Tem and Long Term Capital Gains

Capital gains tax is definitely an aspect which every property seller should
consider in a cost-sensitive market. In India, the sale of a property involves
short-term capital gains tax if it was sold before the completion of three years
of purchase. The tax authorities will consider the profit you generated by the
property sale as regular income for that year and apply tax accordingly. If the
property was sold after three years of its purchase having elapsed, long-term
capital gains tax at the rate of 20 percent. When it comes to long-term capital
gains, which occurs when you sell a house after a period of three years, tax
calculation involves what is Imown as indexation. The acquisition cost
Gain J J3
of the asset is recalculated bascd on indexation, which factors inflation

in its calculation by using the Cost Inflation Index.
Are Capital Gains Tax Rates Lower?

The answer is yes and no. It is yes when individuals fall in the
20%) and above tax slabs. However, most of the taxpayers fall in
the J 00/0 or slabs and therefore for them capital gain tax is not
lower than personal tax rates as is generally considered.
Rich and Wealthy capital gains are income and should be taxed
like other forms of income. It's that simple. The preferential tax
rates on capital gains mean that many upper-income people pay
lower tax rates than others with lower incomes and that capital
and effort are wasted in the search for tax shelters. To start with,
lightly taxing capital gains undermines the progressivity of the
income tax because capital gains are exceptionally concentrated
among the highest-income taxpayers. In 2012, the 400 highest-
income taxpayers received a whopping 12% of all capital gains.
For this "fortunate 400," capital gains made up 57% of their
income. Even among the merely rich—those with incomes over
$1 million—capital gains made up nearly a third of income,
compared with only 1% for those with incomes under $200,000
(The Wall Street Journal, March 1, 2015).
Earnings Management
A corporation's capital gain is affected by numerous items. A
firm can selectively dispose of assets which have substantially
depreciated or appreciated in value. Investments generally
qualify as capital assets; thus, a sale of investments would affect
the firm's capital gains. A firm's sale of property, plant and
equipment would affect the firm's capital gain. Discontinued
operations and extraordinary items also might affect the firm's
capital gain because these events might include capital assets.
Taxatiožl
114
Example
Mr. X sold 10 decimal land situated at Tejgoan industrial area
in 2015 for TK25 million. It incurred advertisement cost
TK50000 and paid brokerage 1/2 percent of sale price. The
acquisition cost of the property in 2010 was TK15 million,
stamp duty being TK2 Iacs and legal cost being TK80000. Mr.
X invested the sale proceeds for another land near his factory in
Tongi, in 2016 cost being TK6 million including all incidental
costs. Mr. X duly informed the DCT his intention to take the
advantage of tax exemption (roll over) -u/s 5,
Compute (i) capital gain and tax u/s 31, ((ii) capital gain tax at 400
deed value, (iii) capital gain tax at TK6000() per 1.65 decimal

area (iv) capital gain tax based on cost inflation index of 110 in
2015 and 100 in 2010.
Solution
(i) Capital gain and tax u/s 31
Sale price TK25 m
Less advertisement TKO,05 m
Brokerage 1/20/0 of25m 0.125
(0.175)
Net sale proceeds
24.83
Less cost ofacquisition
15m
Stamps
02
Legal fees
0.08
(15.28)
Capital gain
9,55
Reinvestment
(6)
Capital gain assessed
3.55
Tax at
(ii) Capital gain and by deed value at 4% of 3.55 0.53
(iii) capital gain tax by size at TKO.06m x (10/1.65) 0.14
(iv) Capital gain and tax by index 0.36
(v) Net sale price
24.83
Question
1, Why gain on sale of shares is exempt (u/s 64-2 and 6 th Schedule

Para 27 of Part B)? Compare our laws with other countries' tax of
this source of income.
2. Differentiate the law and the practice of computing capital gain tax on
land and property.
3. Is the acquisition price of land and property u/s 32 used in practice
for determining capital gain tax?
4. Are the laws for capital gain on shares complied with in practice?
Explain.
5 How is capital gain tax on land and property determined in India?
6. Capital gain tax of 10% and 15% are considered lower than income
tax. Is it really so? Explain.
7. Gain 115What
are short
Inflation adjusted cost
15.28 (110/100) (16.81) tenn and
Capital gain long term
8.02
Tax at capital
1.2
gains?
How are short term and long term capital gains taxed in India?
8. Who are the real gainers of lower capital gain tax? How?
9. How does capital gain tax affect earnings management?
Exercise
1
. Mr. Z sold an apartment situated at Green Road, Dhaka in 2012 for TK20
million. It incurred advertisement cost TK30000 and paid brokerage 1/3rd
percent of sale price. The acquisition cost of the property in 2010 was
TK15 million, stamp duty being TK1.5 lacs and legal cost being TK70000.
Mr. X invested the sale proceeds for another apartment in Gulshan, Dhaka
in 2013 at cost being TK 35million including all incidental costs. Mr. X
duly informed the DCT his intention to take the advantage of tax exemption
(roll over) u/s 5.
in
116
Compute (i) capital gain and tax u/s 31, ((ii) capital gain tax at of deed value,
(iii) capital gain tax at TK240000 per 1.65 decimal area (iv) capital gain tax
based on cost inflation index of I l I in 2012 and 100 in 2010, (v) Shall Mr. Z
roll over or pay capital gain tax? Show calculations [Hints: compare the amount
of capital gain tax exempted and forgone depreciation on new investment to the
extent of capital gain (vi) tax written down value of the new investment [Hints:
cost of new investment less investment of capital gain).
2. Mr. M purchased land and building at Dhanrnondi in Dhaka in

2004 for TK25 million. Ile added some improvements in 2008 for TKIO
million. Ile sold the entire property in 2009 for TK8() million. Compute (i)
capital gain and tax u/s 31, ((ii) capital gain tax at 4% of deed value, (iii)
capital gain tax at TK 240000 per 1.65 decimal area, (iv) capital gain tax
based on cost inflation index of 150 in 2009 and 100 in 2004, (v) Shall Slr.
Z roll over or pay capital gain tax? Show calculations [Hints: compare the
amount of capital gain tax exempted and forgone deptcciation on new

investment to the extent of capital gain (vi) tax '/,ritten value of the new
investment [Hints: cost of new imestrnent less investment of capital gain).
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Income Measurement and

Taxation in Real Estate 13

Real estate business, particularly consfruction of buildings and bridges

Nature of the business

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Less stock of underdeveloped land XXX

Consumption of land during the period

Materials consumption during the year

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Less closing W-I-P

List of Projects with Completion Stage and Revenue

and Project 4: 0.03% complete. Then revenue is recognized project

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Use of Estimates and Judgments

Measurement and Recognition

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As per section 53FF of the Income Tax Ordinance (ITO) 1984, it is

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Deferred tax is recognized in compliance with BAS - 12 "Income Taxes",

Eastern Housing Ltd. Balance Sheet, 2016

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Income Statement, 2016 Expenses:

Income tax expense

Cash flow from operating activities:

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Maximize Capital Gains

Low-income housing tax credits

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Both the products are sold at 13% profit on cost

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Income Measurement and

Our life insurance companies prepare a revenue account but not a

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This article therefore, reviews the taxation regulations related

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volt10tion, External Citt'ltinp,N noncore il)icjct't,

financing and investing activities but lift.' claims are principally

Nearly all companies always showed losses by this method and

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The second method

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principle of periodicity, This accounting principle is an accounting

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The relevant literature, IFRS and World experience

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administrative expenses and depreciation. To these, one more

Life insurance companies around the world except Bangladesh

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activities. If corporation tax rate is a flat one, keeping of two accounts

IFRS 4, accounting for life insurance prescribes the same international

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The study is based on secondary data from annual reports available

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I determined profitability by dividing profit before tax by total revenue.

The unit of study—profit is not available in the financial statements

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This current tax is the tax