BA340.

1 TAXATION LAW &

PRACTICE
Topic 1: Introduction to Taxation
 Topic 1: Introduction to Taxation
Objectives:
1. Explain the basic nature of income tax.
2. Understand the background to income tax law in
PNG by reference to the ITA and other laws.
3. Define and explain basic terms used in
income tax law.
4. Calculate the taxable income by reference to the
tax equation:
Taxable income = Assessable income
less allowable deductions
 Topic 1: Introduction to Taxation
• What is Tax?
Tax is a compulsory levy that is imposed by a
sovereign state on its citizens & non-citizens that is
paid in monetary form, for which the state need
not provide equivalent compensatory services to
the taxpayers for the taxes it so collects.
• What is income tax?
Tax on the income of individuals, companies and
other legal bodies. It is a direct tax that is borne by
the taxpayer who actually “bears the tax burden”
and can not be shifted to others in any way.
 Topic 1: Introduction to Taxation
• Main purposes of taxation
Raise revenue to fund government expenditure;
Fiscal policy tool to stimulate or reduce economic
activities (where needed);
Tool to achieve social objectives.
 Topic 1: Introduction to Taxation
Types of taxes
• Direct Taxes
Direct taxes are taxes levied on income of taxpayers that
must be borne by them. These can not be shifted to third
parties. These are taxes on S/W, business income,
dividend income, rental income, interest income etc.
• Indirect Taxes
Indirect taxes are consumption based taxes that can be
shifted from one party to another along the chain.
Examples are GST, import duties, excise duties, stamp
duties etc.
 Topic 1: Introduction to Taxation
Tax Systems
• Proportional
A fixed % (portion) is levied as tax and that % is
applied on the income or the consumption outlay
to determine taxes. (e.g.10% GST).
• Progressive
The higher the income the higher the taxes.
Personal income tax is a progressive tax system.
• Regressive
The lower the income the higher the % of taxes
 Topic 1: Introduction to Taxation
• Income Tax Law – Background
• Income Tax law is based on legislation (SL) and case
laws (CL). ITA was passed in 1959 and amended
several times, hence its extension ITA 1959 (as
amended).
• Other provisions in the tax legislation
 Income Tax Rates Act
 Income Tax Regulations
 Stamp Duties Act
 Goods & Services Tax
 International Tax Agreements Act
 Topic 1: Introduction to Taxation
• Introduction to language & terms used
 Assessable income (s.46-47)
 Allowable deductions (S.66-68)
 Taxable income (ITA vs GAAP)
 Derivation of income
 Exempt income
 Tax rebates and credits
 Non-allowable deductions
 Capital expenditure
 Losses or outgoings not incurred
 Losses or outgoings of a private or domestic nature
 Allowable deductions (direct & indirect nexus)
 Evidence of expenditure (S.364)
 Residents & non residents taxpayers
 Topic 1: Introduction to Taxation
• Assessable Income
This is the income that is taxable before any deductions are
made; in other words, gross income. The following receipts,
for example, are classified as assessable income:
• Salary or wages
• Interest
• Dividends
• Gross income from a business
• Partnership Income
• Rent
• Bonuses and Commissions
 Topic 1: Introduction to Taxation
• Allowable Deductions (S.66-68)
These are amounts which are allowed to be
deducted from assessable income in order to
arrive at a figure which represents taxable
income.
TI= AI-AD
 Topic 1: Introduction to Taxation
• Allowable Deduction cont.

As a general rule, actual payment need not be made in

order to claim a deduction, so long as a liability is
“incurred”. Allowable deductions include most
expenditure which would normally appear in the profit
and loss accounts of a business (S.68). Allowable
deductions would include:
• purchase of trading stock
• Manufacturing, trading and administrative expenses
• Interest, rentals and royalties paid
 Topic 1: Introduction to Taxation
• Allowable Deductions cont.
– The Income Tax Act contains provisions governing
the allowance of tax deductions for general costs
or outgoings incurred in deriving income or
carrying on a business for that purpose (S.68).
Excluded are expenses of a capital, private or
domestic nature. These provisions will be
considered in detail in later topics.
 Topic 1: Introduction to Taxation
• Taxable Income
– This is actual income subject to tax after
allowable deductions have been subtracted. It is
calculated by subtracting allowable deductions
from assessable income. Taxable income is quite
often different to ‘accounting income’ due to
different treatment on certain items between the
Income Tax Act and generally accepted
accounting principles.
 Topic 1: Introduction to Taxation
• Derived Income
– Income must normally be derived (or earned) to be
subject to tax. Income need not be actually received to
be derived. It is derived even though it is not actually
paid over, when it is reinvested, accumulated, or
capitalised or otherwise dealt with on a tax payer’s
behalf or as he directs. For example, if a taxpayer has a
fixed deposit in his bank for K20,000 on which interest
of K2,000 is credited to his account annually, the
K2,000 is income whether the taxpayer withdrew it or
not (S.13).
 Topic 1: Introduction to Taxation
• Exempt Income
– This is income which is not included in a taxpayer’s
assessable income. However, it must be disclosed
in a tax return. Exempt income includes:
• education allowances, scholarships, etc.
• export sales of certain ‘qualifying goods’, i.e. which
qualify for tax exemption
• certain government pensions
• income of religious institutions, hospitals and charitable
bodies
 Topic 1: Introduction to Taxation
• Exempt Income cont.
– Payments made from exempt income may,
however, be taxable (S.44). It should be
noted that income from illegal sources is
also included as income for tax purposes.
 Topic 1: Introduction to Taxation
• Tax Rebates and Credits
– A tax rebate is a tax allowance which is deducted from
a person’s tax liability in order to arrive at his final
(net) tax liability. It is an amount which is deducted
from tax payable to arrive at the net tax payable
figure. A tax credit, like a rebate, is a deduction from
tax payable. Tax credits are given for taxes already
paid or payable. The amount of a rebate or credit can
never exceed the tax otherwise payable. In some
cases credits may give rise to a refund.
 Topic 1: Introduction to Taxation
• Non Allowable Deductions
– Capital expenditure: expenditure of a
capital nature (eg. extension to premises,
or purchase of machinery) even though
incurred in the course of producing
assessable income, is not deductible under
the Income Tax Act. However, depreciation
is allowable on assets used in the
production of assessable income.
 Topic 1: Introduction to Taxation
• Non Allowable Deductions conts.
– Losses and Outgoings “not incurred”: Certain
expenditure provisions, eg. provisions made in
the company’s accounts for expected future
liabilities, or bad debts, are not allowable as a
deduction for tax purposes. When such future
liabilities are discharged and payment is made or
a bad debt written off in the case of a provision
for bad debts, a tax deduction is allowed.
 Topic 1: Introduction to Taxation
• Non Allowable Deduction
– Losses and outgoings of a private or domestic
nature: Expenditure on the day to day necessities
of life is not allowable for tax purposes. Thus
items such as purchases of food, medical
expenses, life insurance are not allowable
deductions. This may also include expenditure to
earn income; eg. expenditure incurred in travelling
to work, or childminding to enable a mother to
earn income is a private or domestic expense.
 Topic 1: Introduction to Taxation
• Allowable Deduction
– It is not necessary that the purpose of
expenditure be the production of assessable
income. But it should be necessarily incurred
in carrying on a business. The Income Tax
Act looks at the scope of the operations and
activity and requires that the expenditure or
loss in question was relevant or connected to
the production of assessable income.
 Topic 1: Introduction to Taxation
• Allowable Deduction cont.
– Expenditure is also allowed as a deduction
in the particular year it was incurred,
although it may not produce income until a
future year.
 Topic 1: Introduction to Taxation
Tax clearance for overseas remittance
Amounts of money exceeding K200,000 can
be remitted overseas provided a tax
clearance certificate has been obtained,
certifying that no taxes are outstanding and
all tax requirements to date have been met.
This may be obtained from the IRC.
 Topic 1: Introduction to Taxation
 Capital and Income
• Income that is subject to tax has the elements
of periodicity, regularity and recurrence.
• Receipts of capital nature are not taxable
because they are not receipt of income.
Capital gains are taxable in other countries but
not in PNG.
Capital gains
Windfall gains
Gifts not income
Compensation
Mutual concept
 Topic 1: Introduction to Taxation
 Receipts of income are more or less
periodic and regular, and stem from
revenue generating activities –
employment, business, investment, etc.
 Two guidelines for deciding whether receipt
is income or capital:
1. The intention of the tax payer;
2. How often a particular transaction is conducted.
 Topic 1: Introduction to Taxation
• How is taxable income determined?
PNG resident taxable income is calculated as
follows:

Gross income from all sources

Less: exempt income (if any)
= ASSESSABLE INCOME
Less: Allowable deductions
= TAXABLE INCOME
 Topic 1: Introduction to Taxation
How is taxable income determined? (cont’d)
Example
Gross income K20,000
Exempt income 2,000
Allowable deduction 10,000
Tax rebate 50
Rate of tax (for coys) 30 %

Calculate the tax payable for the above

 Topic 1: Introduction to Taxation
Calculation of taxable income and tax payable:
Gross income K20,000
Less: exempt income 2,000
Assessable income 18,000
Less: allowable deductions 10,000
Taxable income 8,000
8,000 x 30% 2,400
Less: tax rebate 50
Net tax payable 2,350