KE3 - FUNDAMENTALS OF TAXATION AND LAW

Suggested Answers and Marking Guide (English)

Suggested Answers and Marking Grid

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PART A

TAXATION

SECTION 1

Answer 01

1(a)

1.1.

Correct answer: A

Equity, progressivity, simplicity, stability

1.2.

Correct answer: D

(iii) only

1.3.

Correct answer: C

Rs. 1,800,000 being net sale proceeds of his residential house in Kandy 1.4.

Correct answer: B

Rs. 1,500,000

Learning Outcome: 1.1.1 State the economic and social functions of taxation

Learning Outcome: 3.1.2 Explain specific adjustments applicable to the computation of Statutory

income of a company, from rent, interest, dividend and profit from trade or business (other than adjustments applicable to intercompany transactions).

Learning Outcome: 2.2.3Calculate the statutory income from other sources of income(including rent, net annual value, interest, dividends, royalties, annuities, winning from lottery, betting or gambling and income from any other source)

Learning Outcome: 5.2.3 Computation of NBT in a straight forward, non-complex scenario

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1.5.

Correct answer: C

Rs. 480,000

1.6.

1. Department of Inland Revenue

2. Provincial Departments of Revenue

3. Department of Customs

4. Department of Excise

1.7.

Profit/(Loss) on disposal = Rs. 120,000

Working (Rs.) Profit = (Selling price – Tax W.D.V.) Selling price = 520,000 WDV =2,000,000-(2,000,000 x 20% x 4yrs) = 400,000 Profit = 520,000-400,000 = 120,000 = 120,000

1.8.

1. Statutory rent income = Rs.150,000

Marking Scheme Learning Outcome: 3.1.5 Explain the tax liability of a company on deemed distributions.

Learning Outcome: 1.2.1 State the role of tax authorities in Sri Lanka.

Learning Outcome: 2.2.1 Calculate the statutory income from a small or medium scale trade,

business, profession or vocation, taking in to consideration allowable and disallowable expenses, capital allowances and disposal of capital assets.

Learning Outcome: 2.2.3Calculate the statutory income from other sources of income(including rent, net annual value, interest, dividends, royalties, annuities, winning from lottery, betting or gambling and income from any other source)

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Working (Rs.) Gross rent =15,000 x 12 180,000 Less: Rates =200,000 x 10% (20,000) Balance 160,000 Allow. For rep. 25% (40,000) Net rent 120,000 NAV 200,000 x (1-25%) 150,000

2. House occupied solely for residential purposes / Floor area does not exceed 500 square feet

1.9.

VAT Payable for the quarter: Rs. 292,500 Output tax (4,500,000 x 12%) = 540,000

Claimable input tax = (360,000-30,000) x 4.5/6 = 247,500

Balance payable (540,000 -247,500) = 292,500

1.10.

Creative Toys PLC – (40,000,000 x 28%) = 11,200,000

Toy Land (Pvt) Ltd – (4,200,000 x 28%) = 1,176,000

Learning Outcome: 5.1.2 Computation of VAT payable in a straightforward, non-complex scenario.

Learning Outcome: 3.1.4 Compute the gross income tax liability and balance tax liability of a small or medium sized company.

Marking Guide Each question carries 2 marks. Total 20 marks.

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SECTION 2

Answer 02

1.

Learning Outcome: 2.2.1 Calculate “statutory income” from a small or medium-scale “trade,

business, profession or vocation”, taking into consideration “allowable and disallowable expenses, capital allowances” and disposal of capital assets.

2.2.2 Calculate employment income (including all cash and non-cash benefits,

excluding terminal benefits).

2.2.3 Calculate statutory income from other sources of income (including rent,

net annual value, interest, dividends, royalties, annuities, winnings from

lottery, betting or gambling and income from any other source).

2.2.4 Identify the “miscellaneous exemptions” under the Inland Revenue Act

(Sec. 13) applicable to an individual and capital gains.

2.3.1. Compute the total statutory income, assessable income and taxable

income taking into consideration relevant statutory deductions and

aggregation of child’s income.

2.4.1 Identify rates of income tax applicable to an individual, (including

“ceiling of tax rates” introduced from time to time).

2.4.2 Compute gross income tax liability for an individual.

2.4.3 Compute the balance tax payable, taking into consideration the various

types of tax credits.

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Mr. Uthpala Perera

Computation of Taxable Income

Year of Assessment 2013/14

Rs.

Rs.

Rs.

Marks

Employment income

Net Salary

Add: EPF Deduction 180,000/12 x 8

PAYE Deduction

Gross Salary

1,305,000

120,000

75,000

1,500,000

1,500,000

1

Festival Allowance 50,000 1/2

Medical bills reimbursed 60,000 1/2

Housing Benefit

(a) Rental Value (200,000 + 20%)

(b) Rent paid to owner (25,000 x 12)

Whichever is higher

Gross remuneration does not exceed 1.8 million

Therefore value of benefit limited Rs. 120,000

240,000

300,000

300,000

120,000

1,730,000

1

Profession – Consultancy Service

Adjustment of Net Profit for Tax Purposes + -

Net Profit 600,000

Salaries paid to spouse is an allowable expenditure,

Added to Statutory Income of Mr. Perera

-

-

Advertising Expenses

Staff Vacancy Notice 12,000 Fully allowed

Commercial Advertising 48,000 x 25% D/A

12,000

1/2

1/2

Purchase of Computer – Capital Expenditure D/A 80,000 1/2

Entertainment Expenses D/A 20,000 1/2

Accounting Depreciation 32,000 1/2

Electricity & Telephone – 80,000 x 80% Personal 64,000 1/2

Depreciation Allowance

Furniture (2011/2012) 60,000 x 20%

Computer (2013/2014) 80,000 x 25%

12,000

20,000

1/2

1/2

808,000 32,000

(32,000)

Adjusted profit 776,000 776,000

Interest on Fixed Deposit (Final Tax Deducted) 276,000 Not

Taxable

- 1/2

Profit on Sale of Shares 300,000 Exempted - 1/2

Salaries paid to Spouse 150,000 1/2

Aggregation of Child’s Income

Interest Income (Gross)

45,000

1/2

Total Statutory Income 2,696,000

Less: Deductions under Section 32

Housing Loan Interest Paid

Credit Card Interest – Not Allowed

123,000

-

1/2

1/2

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Total Deduction

Note: Deduction limited to non-employment income of

(2,696,000 – 1,730,000) Rs. 966,000.

123,000

(123,000)

1/2

Assessable Income 2,573,000

Less: Tax Free Allowance (500,000) 1/2

Less: Allowance for Qualifying Payments Limit Allowanc

e

a) Donation to Govt. School 100,000 N/A 100,000 1/2

b) Donation to Approved Charity 80,000 Lower of

1/3 of A.I.

or 75,000

75,000 1/2

c) Premia on Insurance Policy for Incurable

Diseases

N/A 48,000 1/2

d) Qualifying Payment on Employment Income N/A 100,000 (323,000) 1/2

Note: Deduction for Q/Payments other than (d) is limited

to balance Non-employment income of (966,000 – 123,000)

Rs. 843,000

1/2

Taxable Income 1,750,000

Computation of Tax Liability

On 1st 500,000 @ 4% 20,000 1/4

On next 500,000 @8% 40,000 1/4

On profit from professional service (Balance) 750,000 @10% 75,000 1/2

Gross Income Tax 1,750,000 135,000

Less: Tax Credits

PAYE Deductions 75,000

Self-Assessment Tax Paid 40,000 (115,000) 1/2

Balance Tax Payable 20,000

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Marking grid

2 marks for explaining

Marking grid

3 marks for explaining

2.

Even though he has paid total income tax due for the period he has legal obligation to submit

a return of income for the year of assessment 2012/2013, to the department of Inland

Revenue. The return of income should be submitted on or before 30th November 2013.

Therefore what he has done in not correct. (He is not correct.)

3.

i) It should be submitted in writing, addressing to the CGIR, clearly explaining the

grounds for appeal.

ii) Appeal must be made within 30 days since the receipts of the assessment

iii) The proof of income tax payments made should also be attached to the appeal

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PART B

LEGAL FUNDAMENTALS

SECTION 1

Answer 01

1(a)

1.10.

Correct answer: D

To the Mediation Board.

1.11.

Correct answer: B

Mahela’s reply to Kumar is the counter offer to Kumar’s initial offer.

1.12.

Correct answer: D

Every partner is not entitled to take part in the management of the partnership business. 1.13.

Correct answer: D

Authorized disclosure of information, which enables another to access any service

provided by a computer.

Learning Outcome: 1.3.1 Identify the Courts in Sri Lanka and their functions

Learning Outcome: 2.1.1 Explain offer & acceptance

Learning Outcome: 5.7.5 State the relationship between partners

Learning Outcome: 8.2.1. State briefly on each of these Acts: Prevention of Money Laundering

Act No. 05 of 2006, Electronic Transactions Act No. 19 of 2006, Computer Crimes Act, Consumer Protection Act, Intellectual Property Act No. 36 of 2003.

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1.14.

Correct answer: A

Documentary Credits.

1(b)

1.15.

When it is payable after sight

presentment for acceptance is necessary to fix the date for payment.

Where it is expressly stipulated that the bill shall be presented for

acceptance.

Where it is payable elsewhere, other than at the place of residence or

business of the drawee.

1.16.

• “Uberrimae fidei” or “Utmost Good Faith”

- A very important aspect of all contracts of insurance is that a duty is

imposed on the person applying for the insurance cover, to exercise

“utmost good faith” in all his declarations to the insurer. In Latin, “utmost

good faith” is referred to as “uberrimae fidei”.

Marking Scheme Learning Outcome: 9.1.1 Explain the process of international sale of goods

Learning Outcome: 4.1.1- Define and identify differences between cheques, bills of exchange and promissory notes.

Marking Grid Listing instances where presentment is compulsory – 1 mark each

Learning Outcome: 6.1.3 - Explain the applicable principles in a contract of insurance relating to uberrimae fidei .curable interest and indemnity (including total and partial insurance)

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• The Principle

- This principal of “uberrimae fidei” means that the person seeking the

insurance, owes a duty to disclose to the insurer, every material fact,

which he knows or ought to know, about the insurance, so that the

insurer can properly evaluate the risk that he is undertaking.

- The failure to disclose a material fact by the person seeking the

insurance, gives the insurer the right to reject payment on the policy i.e.

such failure makes the policy voidable.

- Material Facts - A fact is material, if it can influence the judgment of a

prudent insurer, in deciding whether to accept the risk or not, and in the

event the risk is accepted in fixing the premium.

1.17.

Colombo Stock Exchange - Regulatory Role and Main Functions

The CSE offers a variety of tools to help investors monitor trading activity and keep the pulse of the market. It has facilities for the secondary trading of Corporate and Government Securities.

The CSE provides a fully automated trading platform, for the participants. It was one of the first Exchanges in the Asian Region to successfully automate its clearing and settlement functions, with the installation of a Central Depository and an electronic clearing and settlement system for share transactions (in 1991), and an Automated Trading System (ATS) (in 1997).

A separate Trading System (DEX) and a separate Clearing and Settlement mechanism is in place for debt securities. All Government Debt can be traded through the DEX system.

Marking Grid For defining the term “uberrimae fidei” – 1 mark For explaining its application in insurance contracts – 3 marks

Learning Outcome: 1.4.1 Explain the regulatory role of each of these institutions:

Institute of Chartered Accountants, Sri Lanka Accounting and Auditing Standards Monitoring Board, Securities and Exchange Commissions, Colombo Stock Exchange, Board of Investment, Registrar of Companies, Dept. of Customs, Central Bank (Exchange Control Department).

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The CSE has two main price indices, namely the All Share Price Index (ASPI) and the Milanka Price Index (MPI). The ASPI shows the price fluctuations of all the listed companies and covers all the traded companies during a market day.

1.18.

Matters relating to members of the Armed Services and Police.

Appointments, transfers, dismissals or disciplinary control of public

officers.

Matters relating to the Auditor General.

Matters relating to the Commissioner of Elections

1.10.

Facilities to be provided by the Employer

To provide suitable and sufficient;

• Means of lighting and ventilation,

• Facilities for employees to take their meals in the premises.

• To provide sanitary conveniences and washing facilities.

• To provide seats behind the counter for women shop assistants.

• To maintain the workplace in good repair and order.

Marking Grid For stating the regulatory role and main functions – 4 marks

Learning Outcome: 9.1.2 Explain the process of international commercial dispute resolution.

Marking Grid For listing the ways that a contract of sale may be formulated - 4 marks

Learning Outcome: 7.3.3 Identify facilities to be provided by employers under the Shop & Office Act.

Marking Grid For listing the facilities – 4 marks

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SECTION 2

Answer .02

1. Yes, the day the letter was posted to the post box - 8th January

2.

Discuss the postal rule with Adams Vs Lindsel case facts “acceptance by post”,

relate the court decision; Adams v Lindsel (1818) 106 ER 250

Facts of the case: The defendant wrote to the claimant offering to sell them some

wool and asking for a reply 'in the course of post'. The letter was delayed in the post.

On receiving the letter the claimant posted a letter of acceptance the same day.

However, due to the delay the defendant's had assumed the claimant was not

interested in the wool and sold it on to a third party. The claimant sued for breach

of contract.

Held: There was a valid contract which came in to existence the moment the letter

of acceptance was placed in the post box.

This case established the postal rule. This applies where post is the agreed form of

communication between the parties and the letter of acceptance is correctly

addressed and carries the right postage stamp. The acceptance then becomes

effective when the letter is posted.

Learning Outcome:

2.1.1 Explain the requisites of a valid contract (offer and acceptance, intention to create legal relations, consideration, capacity and form. Definition of a contract, agreement, capacity to contract, form of contracts, reality of consent.

Marking Grid For identifying and stating that there is a valid acceptance -2 marks

Marking Grid For explaining the postal rule in detail - 4 marks

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3.

By Revocation

The basic requirement is that a revocation requires communication to the offeree

of the fact that the offer is no longer open. Under the postal rule, although an

acceptance is effective upon posting - a revocation is only effective UPON RECEIPT.

Byrne v Van Tienhoven - revocation requires communication (1880) LR 5 CPD 344

Common Pleas Div

• The court took the view that a revocation is not effective prior to its

communication, and that the posting of a letter of revocation does not constitute

communication of it.

• The rationale is that a state of mind not notified cannot be regarded in dealings.

The principle is that the writer of an offer impliedly accepts that a posted answer

will be sufficient - and that the post office will act as agent for the purpose -

therefore delivery to the post office is delivery to the other party.

• But this principle is not applicable to the withdrawal of an offer. Any other view

would lead to great inconvenience. Nobody could act on an acceptance until a

further stage had been gone through of confirming that a revocation had not been

sent to them in the meantime.

• The Communication of the revocation, can be made either by the offeror, or by

a source which the offeree believes to be reliable

Marking Grid For discussing the principles relating to revocation of an offer - 4 marks

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Answer .03

1.

The principal is the one who will have to ratify the transaction. Looking at the

transaction, the Principal will not ratify the transaction due to the secret profit the

agent got.

Requirements for the ratification

• The agent must purport to act as agent for a principal who is in

contemplation:

• There should be an act capable of ratification

• The principal must be in existence

• The principal must be competent to contract:

• The principal must have full knowledge of material facts:

• Whole transaction must be ratified within reasonable time:

• Ratification must not injure a third person

2.

This could be considered as a secret profit. Any advantage, any benefit, is

considered as a secret profit which is not disclosed to the principal. Agent’s

responsibility to inform any additional gains to the Principal since it is principal’s

money. If not the principal can cancel the agency relationship and claim damages

from the agent.

Learning Outcome:

5.1.1 Explain the circumstances under which a relationship of Principal-Agent would be recognized by mutual agreement, by ratification, by necessity and by estoppels. 5.3.1 State the duties of an agent towards principal

Marking Grid For explaining the requirements of a ratification – 7 marks

Marking Grid For explaining the principle on secret profits – 3 marks

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Answer. 04

1.

Lease:

In simple words, Lease is a financial contract between the business customer (user)

and the equipment supplier (normally owner) for using a particular

asset/equipment over a period of time against the periodic payments called “Lease

rentals”.

Lease generally involves two parties i.e. the lessor (owner) and the lessee (user).

Under this arrangement, the lessor transfers the right to use to the lessee in return

of the lease rentals agreed upon. Lease agreement can be made flexible enough to

meet the financial requirements of both the parties.

Hire Purchase:

Hire Purchase is a kind of installment purchase where the businessman (hirer)

agrees to pay the cost of the equipment in different installments over a period of

time. This installment covers the principal amount and the interest cost towards the

purchase of an asset for the period the asset is utilized. The hirer gets the possession

of the asset as soon as the hire purchase agreement is signed. The hirer becomes

the owner of the equipment after the last payment is made. The hirer has the right

to terminate the agreement any time before taking the title or the ownership of the

asset.

Difference between Lease and Hire Purchase:

• Ownership of the Asset: In lease, ownership lies with the lessor. The lessee

has the right to use the equipment and does not have an option to purchase.

Whereas in hire purchase, the hirer has the option to purchase. The hirer

becomes the owner of the asset/equipment immediately after the last

installment is paid.

• Depreciation: In lease financing, the depreciation is claimed as an expense in

the books of lessor. On the other hand, the depreciation claim is allowed to the

hirer in case of hire purchase transaction.

Learning Outcome:

6.2.1 Explain concepts of Hire- Purchase. 6.3.1 Explain the concept of Leasing 6.3.3 Explain the default by Lessee and remedies available for Lessor

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• Rental Payments: The lease rentals cover the cost of using an asset.

Normally, it is derived with the cost of an asset over the asset life. In case of hire

purchase, installment is inclusive of the principal amount and the interest for

the time period the asset is utilized.

• Duration: Generally lease agreements are done for longer duration and for

bigger assets like land, property etc. Hire Purchase agreements are done mostly

for shorter duration and cheaper assets like hiring a car, machinery etc.

• Tax Impact: In lease agreement, the total lease rentals are shown as

expenditure by the lessee. In hire purchase, the hirer claims the depreciation of

asset as an expense.

• Repairs and Maintenance: Repairs and maintenance of the asset in financial

lease is the responsibility of the lessee but in operating lease, it is the

responsibility of the lessor. In hire purchase, the responsibility lies with the

hirer.

• Extent of Finance: Lease financing can be called the complete financing

option in which no down payments are required but in case of hire purchase,

the normally 20 to 25 % margin money is required to be paid upfront by the

hirer. Therefore, we call it a partial finance like loans etc.

• The option of lease finance or the hire purchase can be opted by the

businessmen but they should be analyzed properly as to how much the option

suits to the business requirement and situations.

Marking Grid For explaining the terms finance lease and hire purchase -2 marks For explaining the difference between a finance lease contract and a hire purchase contract - 4 marks

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2.

Rights available for a lessor against the lessee over the lease contract.

• Cancel the lease contract.

• Proceed respecting goods not identified to the lease contract.

• Withhold delivery of the goods and take possession of goods previously

delivered.

• Stop delivery of the goods by any bailee.

• Dispose of the goods and recover damages, or retain the goods and recover

damages, or in a proper case recover rent.

• Exercise any other rights or pursue any other remedies provided in the lease

contract.

Answer. 05

1. In this scenario, Warren did not signify to Karen, his direct acceptance or

refusal to buy these jewels.

But the fact that Warren mortgaged these jewels to Morty, amounts to

Warren adopting the purchase of the jewels from Karen.

Therefore the property in the jewels, has passed to Warren.

Similar facts were discussed in the decided case, Kirham v Attenborough

[1897] 1 Q.B. 201

Marking Grid

For discussing the rights available for a lessor against the lessee over the lease contract - 4 marks

Learning Outcome: 3.3.1 Discuss the time at which there is a passing of risk and a transfer of title (unascertained goods, reservation of title, instalment deliveries, sales by auction, sale by person not the owner). 3.4.1 Explain the remedies which are available to a buyer and seller, including rights of an “unpaid seller”.

Marking Grid One mark for each point (maximum 4 marks)

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2. In the given scenario, Warren did not give his consent to Morty to sell the

jewels to anyone, leave alone Jonny.

Under the Sale of Goods Ordinance, Jonny will eventually get the same title

to the jewels, as what Morty had.

Since Morty did not have a good title to these jewels, Morty too will not get

a good title to them.

Therefore Jonny does not get the ownership of these jewels.

3. In this scenario, Karen is an un-paid seller.

Though an un-paid seller has many rights under the Sale of Goods

Ordinance, given the facts of the scenario, the right applicable to Karen is

the right to maintain an action against Warren, for the recovery of the sales

price for these jewels.

Marking Grid One mark for each point (maximum 4 marks)

Marking Grid Two marks for the points