PRACTICE & REVISION KIT

CA SRI LANKA CURRICULUM 2020

SL 3 Corporate Taxation
 Fifth Edition 2020

www.casrilanka.com

2020

ii
Contents

Page
Question
Questions Answers

1. Income tax liability of a resident company

1.1 Information Technology Industry 1 4
1.2.Construction Industry 8 11
1.3.Mixed activities 17 23
2.Management of Value-Added Tax (VAT)
2.1 Question 1 29 36
2.2 Question 2 32 43
2.3 Question 3 34 48
3.Taxation of non-residents and international taxation 29 36

iii
Contents
How to use this Practice & Revision Kit

This Practice & Revision Kit comprises banks of practice questions of the style that
you will encounter in your exam. It is the ideal tool to use during the revision phase of
your studies.
Questions in your exam may test any part of the syllabus so you must revise the
whole syllabus. Selective revision will limit the number of questions you can answer
and hence reduce your chances of passing. It is better to go into the exam knowing a
reasonable amount about most of the syllabus rather than concentrating on a few
topics to the exclusion of the rest. You should at all costs avoid falling into the trap of
question spotting, that is trying to predict what are likely to be popular areas for
questions, and restricting your revision and question practice to those.
Practising as many exam-style questions as possible will be the key to passing this
exam. You must do questions under timed conditions and ensure you write full
answers to the discussion parts as well as doing the calculations.
Planning your revision
When you begin your course, you should make a plan of how you will manage your
studies, taking into account the volume of work that you need to do and your other
commitments, both work and domestic.
In this time, you should go through your notes to ensure that you are happy with all
areas of the syllabus and practise as many questions as you can. You can do this in
different ways, for example:
 Revise the subject matter a module at a time and then attempt the questions
relating to that module; or
 Revise all the modules and then build an exam out of the questions in this
Practice & Revision Kit. Review the exam structure and then group together the
relevant number of MCQs and longer questions from different syllabus areas to
create a practice exam.
Using the practice questions
The best approach is to select a question and then allocate to it the time that you
would have in the real exam. All the practice written response questions in this
Practice & Revision Kit have mark allocations, so you can calculate the amount of time
that you should spend on the question.
However, this is an approximate guide: for example, some MCQs are very short and
just require a factual response, which you either know or you don’t, while others are
more complex, requiring calculations, which will inevitably take more time.

iv
Using the suggested solutions
Avoid looking at the answer until you have finished a question. It can be very
tempting to do so, but unless you give the question a proper attempt under exam
conditions you will not know how you would have coped with it in the real exam
scenario.
When you do look at the answer, compare it with your own and give some thought to
why your answer was different, if it was.
In multiple choice questions if you did not reach the correct answer make sure that
you work through the explanation or workings provided, to see where you went
wrong. If you think that you do not understand the principle involved, go back to your
own notes or your study materials and work through and revise the point again, to
ensure that you will understand it if it occurs in the exam.
Passing the [Business Level [I or II] – Business Environment and Economics
If you have honestly done your revision then you can pass this exam. What you must
do is remain calm and tackle it in a professional manner. There are a number of
points which you should bear in mind.
 You must read the question properly. Students often fail to read the question
properly and miss some of the information. Time spent reading the question a
second time would be time well spent. Make yourself do this, don't just rush into
it in a panic.
 Stick to the timings and answer all questions. Do not spend too long on one
question at the expense of others. The number of extra marks you will gain on
that question will be minimal, and you could have at least obtained the easy
marks on the next question.

v
Format of the exam

Mode: Paper based examination, open book

Time: 3 hours
Pass Mark: 50%

The exam comprises of two sections, as follows:

Section 1
Total 50 marks: Two (2) questions of twenty five (25) marks each based on complex
scenarios requiring evaluation and solutions based on synthesis.
Section 2
Total 50 marks: Common ‘pre-seen’ provided prior to the exam to familiarise with
particular business context, and at exam ‘un-seen’ material provided to set the scene
for assessment under each course module. Answering needs a balancing of a number
of angles, and delivered in a professional manner.

vi
Exam techniques

Using the right techniques in the real exam can make all the difference between
success and failure.
Here are a few pointers:

1. Allocate the time available to the questions. You have 120 minutes to answer
50 questions which is an average 2.4 minutes per question, however this should
only be taken as a rough guide as some questions may require less time to
answer than others.
2. Make sure that you attempt every objective test question. Do not leave any
blank. If you run out of time or are not sure of an answer you should select the
option you think is most suitable. You can come back to the question later if
time permits.
3. Read the question. Read it carefully once, and then read it again to ensure that
you have picked everything up. Make sure that you understand what the
question wants you to do, rather than what you might like the question to be
asking you.
4. If you finish the exam with time to spare, use the rest of the time to review your
answers and to make sure that you answered every objective test question.

vii
 Action verbs checklist

Knowledge Process Verb List Verb Definitions

Tier - 1 Remember Define Describe exactly the nature, scope or meaning

Recall important
information Draw Produce (a picture or diagram)

Identify Recognise, establish or select after consideration

List Write the connected items one below

the other
Relate To establish logical or causal connections

State Express something definitely or clearly

Tier - 2 Calculate/Compute Make a mathematical computation

Comprehension
Explain important Discuss Examine in detail by argument showing
information different aspects, for the purpose of arriving at a
conclusion
Explain Make a clear description in detail
revealing relevant facts
Interpret Present in understandable terms or to translate

Recognise To show validity or otherwise, using knowledge

or contextual experience
Record Enter relevant entries in detail

Summarise Give a brief statement of the main points

(in facts or figures)

Classify Allocate into categories

Describe Communicate the key features

Provide Give illustrations to support or illuminate

a point or assertion

Tier - 3 Application Apply Put to practical use

Use knowledge in a
Assess Determine the value, nature, ability
setting other than the or quality
one in which it was
learned/solve close- Demonstrate Prove, especially with examples
ended problems
Graph Represent by means of a graph
Prepare Make ready for a particular purpose

Prioritise Arrange or do in order of importance

Reconcile Make consistent with another

Solve To find a solution through calculations and/
or explanations

viii
Knowledge Process Verb List Verb Definitions

Conduct Organize and carry out a task

Communicate Transmit thoughts or knowledge

Display Make evident or noticeable

Perform Do or execute, usually in the sense of

a complex procedure

Reconcile Make or prove consistent or compatible

or show differences

Set Fix or establish

Select Choose from a range of options

or possibilities
Support Assist to make decisions by providing
appropriate information about
respective concepts
Use Apply in a practical way
Undertake Commit to do or perform
Tier - 4 Analysis Analyse Examine in detail in order to determine
the solution or outcome
Draw relations among
Compare Examine for the purpose of
ideas and to compare
discovering similarities
and
Contrast Examine in order to show
contrast/solve open- unlikeness or differences
ended problems
Construct Build or make a diagram, model
or formula

Differentiate Constitute a difference that

distinguishes something
Outline Make a summary of significant features

Write Provide word descriptions to express an opinion

or idea
Tier - 5 Evaluate Advise Offer suggestions about the best course of
Formation of action in a manner suited to the recipient
judgments and Convince To persuade others to believe something
decisions about the using evidence and/or argument
value of methods, ideas, Criticise Form and express a judgment
people or products
Comment Provide written remarks expressing an opinion
in both positive and negative perspectives
Evaluate To determine the significance by careful appraisal

Conclude Form a judgment about, or determine or resolve

the outcome of, an issue through a process
involving reasoning
Determine Ascertain or conclude after analysis and
consideration; judge

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Knowledge Process Verb List Verb Definitions
Justify Give valid reasons or evidence for

Review Study critically with a view

to correction or improvement
Recommend A suggestion or proposal as to the
best course of action
Resolve Settle or find a solution to a
problem or contentious matter
Validate Check or prove the accuracy

Tier - 6 Synthesis Compile Produce by assembling information

Solve unfamiliar problems by collected from various sources
combining different aspects Design Devise the form or structure according to
to form a unique or novel a plan
solution Develop To disclose, discover, perfect or unfold a
plan or idea

Propose To form or declare a plan or intention

for consideration or adoption

Anticipate Foresee, or experience or realise

beforehand

Draft Write original material for the scrutiny

of others

Formulate Devise and put into words

Plan Devise the plan for an assurance

engagement

Report Give the formal final conclusion for an

assurance engagement

Submit Send a completed document to a

particular party

Suggest Put forward an idea or give reasons

Synthesize Make or propose a new concepts or ideas

by combining existing knowledge in
different aspects

x
 Question 1

Information Technology Industry

Best App Ltd (BAL) is a company incorporated in Sri Lanka which is a subsidiary company of the
Holding company in Singapore. BAL provides services to overseas customers as well as to the local
customers. The company started the operation in Sri Lanka only three years back, and prior to 1.4.2018
there was a loss in the operations in Sri Lanka. The loss carried forwarded from 31.3.2018 consists of
loss relating to overseas operations amounting to Rs 20,500,000 and the loss relating to local business
operations amounting to Rs 10,000,000/-. Since the overseas operations were exempted under the
previous Act , BAL had kept separate records of the operations in order to fulfill the requirements under
section 106(11) of the IR Act No 10 of 2006. In the year of assessment 2018/2019 , the loss was recovered
and the company made profits.

Accounts and supporting documents for the year ended 31.3.2019 are as follows:

Detailed Income Statement – Year ended 31.3.2019

Notes Rs. 000’
Revenue 1 850,000
Net operating cost 2 (425,000)
Gross profit 425,000
Staff cost 3 (89,000)
Depreciation & amortization 4 (76,000)
Other operating expenses 5 (21,000)
Other operation income 6 97,000
Finance income 7 8,500
Profit before tax 344,500

Note 1 – Revenue
Rs . 000’
Local services 450,000
Foreign services 400,000
Total 850,000

Note 2 – Net operating cost

Rs.000’
Cost of Accessories 83,000
Frequency charges 35,000
Interconnection charges 65,000
IDD charges 43,000
Roaming cost 94,000
SMS charges 500
Cess 13,400
Postpaid charges 360
Other direct expenses 90,740
Total 425,000

Note 3 - Staff cost

Rs. 000’
Salaries & wages 40,000
Bonus 20,000
Other employees related cost 29,000
Total 89,000

CA Sri Lanka 1
Note 4 - Depreciation & amortization
Rs 000’
Depreciation on property , machinery & equipment 70,000
Amortization of intangible assets 6,000
Total 76,000

Note 5- other operational expenses

Rs 000’
General administration expenses 20,500
Operating lease rentals - one of the directors motor 500
car used for official travelling
Total 21,000

Note 6- other operational income

Rs 000’
Rent income 77,000
Profit on sale of fixed assets 10,000
Written off of loan given from parent company 10,000
Total 97,000

Note 7 – Financing income

Rs 000’
Interest income – bank deposits 3,500
Interest income FCBU 6,500
Financial cost
Interest payable to parent company (1,000)
Interest paid to foreign bank loan (500)
Total 8,500

Other information
(1) Schedule of capital allowances
Year of purchase Description Cost Rs
2015/2016 Building purchased 150,000,000
2015/2016 Computer lab constructed but 80,000,000
completed in 2018/2019
2016/2017 Telecom equipment 50,000,000
2015/2016 Computers ( Rs 25,000,000 100,000,000
worth of computers were sold
during the year)
2018/2019 New computers 30,000,000
2018/2019 Software purchased and the 50,000,000
expected life time is 10 years
2015/2016 Motor car ( sold during the year) 20,000,000

(2) Since the company constructed a new computer lab, activities carried out in that existing building
was shifted to the new place. The additional space available in the old building was rented out to a
telecom company expecting easy access to telecom connectivity and enable services. Annual rent
is Rs 80,000,000/- however, certain telecom services provided by the telecom company was not
paid and deducted from the rent showing the net rent in the accounts
2 CA Sri Lanka
 (3) The profit on sale of assets consist of the following
(i) A motor car purchased by the company in 2015/2016 to be used by the managing director
was sold during the year for Rs 18,000,000/- whereas, a part of computers were sold
during the year for Rs 27,625,000 as new computers were purchased by the company
during the year.
(4) The parent company granted a loan in the Y/A 2015/2016 and partly paid up to the Y/A 2017/2018
despite of losses incurred in 2017/2018. However , considering the losses incurred by the company

(5) Parent company agreed to write off the loan balance including part of the interest outstanding in
Y/A 2018/2019.
(6) The expenses are equally applicable for both foreign and local services. Out of the foreign revenue
Rs 70,000,000 is for the services provided to India and Rs 50,000,000 for the services provided to
Bahrain. Since the services are provided being in Sri Lanka, none of the overseas services are
related to permanent establishments in those countries. Hence, there is no liability in source
countries except withholding tax liability since Sri Lanka - India and Sri Lanka - Bahrain double
taxation agreements provided an Article relating to technical fee (Article 12) in which even
without a Permanent Establishment, withholding tax at 10% needs to be deducted. The 10% tax so
deducted in India is Rs 7,000,000 and in Bahrain is Rs 5,000,000/-)

(7) Company has paid ESC Rs 20,000,000

CA Sri Lanka 3
Answer
Tax Computation for the year ended 31.3.2019
Note Rs Rs
Business income (Section 6)
Profit before tax 344,500,000
Less :
Interest income 7 8,500,000
Other operating income 6 97,000,000
Telecom expenses 6 3,000,000
Interest paid on foreign loan 7 500,000
Capital allowances 8 50,415,000 (159,415,000)
185,085,000
Add:
Depreciation and amortization 4 76,000,000
Assessable charge 6 21,375,000
Operating lease 5 500,000
Write off of the loan 6 10,000,000 107,875,000
Profit from software business 292,960,000
Other business income :
Rent income 6 80,000,000
Interest income 7 10,000,000 90,000,000
Adjusted profit 382,960,000
Less carried forward loss as calculated 1 (10,000,000)
Assessable income 372,960,000
Deductions ( qualifying payments (section 3, section 52 & Nil
the Third Schedule)
Taxable income 372,960,000
Tax payable 52,214,400
14% - predominantly providing information technology
services [First Schedule – paragraph 4(2)(g) and the
definition of “providing information technology “referred to
in paragraph 4(3) of the First Schedule, percentage of other
business turnover 850+ 80+10 = 940 Mn 850/940*100 =
99%]
Less :
ESC (20,000,000)
WHT on interest 5% on Rs 10,000,000 500,000
WHT on rent income 10% on Rs 80,000,000 8,000,000 (8,500,000)
Foreign tax Credit attributable to income liable in Sri Lanka 9 (5,790,268)
(Section 80)

Balance payable 17,924,132

4 CA Sri Lanka
 Notes
(1) Revenue & attributable profit on foreign income
Rs Rs
Since the expenses are equally applicable to both local and foreign income Local profit Foreign profit
( all the activities performed in Sri Lanka ) 155,096,470 137,863,530
- adjusted profit from local activities (Rs 292,960,000/850, *
450)
- Adjusted profit from foreign activities
(Rs 292,960,000/850*400 )
The loss relating to overseas operations Rs 20,500,000 carried forward is 10,000,000
not claimable since overseas operations were exempt from income tax
prior 1.4.2018 under section 13(ddd) of the IR Act No 10 of 2006.
However, the loss relating to local business operations of Rs 10,000,000/
is claimable under section 19 ( and as provided in the transitional
provision gazette. )
Adjusted profit 145,096,470 137,863,530

(2) Note 2 - Net operation cost- all allowable expenses – No Adjustments

(3) Note 3 – Staff cost – No adjustment
(4) Note 4 – Depreciation and amortization - book depreciation , added back
(5) Note 5 – Other operating expenses - operation lease is for a car used by one of the managing director
for his official travelling, not allowable. Other expenses are allowable, no adjustment.
(6) Note 6 - Other operating income
- Rent income
Actual rent income is Rs.80,000,000/- the different of Rs.3,000,000 is telecom service
expenditure net off with rent received.
- Profit on sale of fixed assets
Sale of Motor car Rs
Sale price 18,000,000
Cost 20,000,000
Loss on sale ( no capital allowances were allowed on motor cars ) (2,000,000)
Sale of Computers
Sale price 27,625,000
Cost 25,000,000
Book depreciation @12.5% for 3 years 9,375,000
WDV (15,625,000)
12,000,000
Net profit transferred to P&L account 10,000,000
(Rs 12,000,000 – 2,000,000)
Adjustment for Tax purposes
Sale price 27,625,000
Capital allowances claimed from to 2015/2016 to 18,750,000
2017/2018 @ 25% ( information technology
equipment)
WDV (Rs 25,000,000 – 18750,000) (6,250,000)
Assessable charge 21,375,000
Loss on disposal of motor car is not deductible, as the loss can be -
allowed only on assets for which capital allowance is climbable under
section 16.

CA Sri Lanka 5
 - Write off of the loan given by the head office
Loan written off is a realization of a liability. Since it was a business loan forming part of the
business income effectively connected with the business. Section 40. As the loan interest
accrued is not payable such amount is also treated as part of the profit on realization of the
liability. Alternatively, interest payable could be disallowed. Loan outstanding represent the
balance loan payable with the interest credited to the loan account .

(7) Financial income

Rs 000’ Rs .
Interest income – bank deposits 3,500 10,000,000
Interest income FCBU 6,500
Total interest income is liable to tax , however, it may be effectively connected with the
business , hence treated as business income but not income relating to software operation
, However, since the company predominantly carries on the business of IT services
interest income ( whether business income or investment income) the same concessionary
rate of 14% is applicable)
Financial cost
Interest payable to parent company Rs 1,000,000
Not claimable as the loan was written off including interest accrued ( see Note 6)
Interest paid to foreign bank loan Rs 500,000
Claimable as it is used in the production of income
(8) Capital allowances
Year of Description Cost Rs Rate Annual
purchase allowance Rs
2015/2016 Building purchased 150,000,000 Not eligible
2015/2016 Computer lab constructed but completed in 80,000,000 1/20 4,000,000
2018/2019
( Section 16, eligible only with use , hence the
first year claim is in 2018/2019 and continued
for 20 years)
2016/2017 Telecom equipment – under plant & machinery 50,000,000 331/3% 16,665,000
– continued with the same rate since acquired
prior to 1.4.2018 – Ref. transitional Gazette)
2015/2016 Computers ( Rs 25,000,000 worth of 100,000,000 25% 18,750,000
computers were sold during the year) on the
balance Rs 75,000,000
2018/2019 New computers – claim within 5 years – (Ref 30,000,000 1/5 6,000,000
4th Schedule )
2018/2019 Software purchased and the expected life time 50,000,000 1/10 5,000,000
is 10 years – intangible asset eligible to claim
1/10 based on life time
2015/2016 Motor car ( sold during the year) 20,000,000 - Not eligible
50,415,000

6 CA Sri Lanka
 (9) - Foreign Tax Credit
Rs Rs
Services to India 70,000,000
profit attributable to Indian operation 70,000,000/850,000,000* 24,126,117
292,960,000
Services to Bahrain 50,000,000

profit attributable to Bahrain operation 50,000,000/850,000,000* 17,232,941

292,960,000
Total 41,359,058
WHT deducted - India 7,000,000
WHT deducted – Bahrain 5,000,000 12,000,000
Sri Lankan tax attributable 52,214,400 /372,960,000* 5,790,268
Total tax payable/ total assessable income * adjusted profit 41,359,058
from services to India & Bahrain

WHT deducted Rs 12,000,000 (WHT > actual liability on such activities hence full WHT deducted in not
claimable) . the deduction is limited to Rs 5,790,268

CA Sri Lanka 7
Question 2

Construction Industry
Ivory Construction (Pvt) Ltd is a company incorporated in Sri Lanka engages in construction
activity in Sri Lanka and in Maldives through its branch office. Total turnover for the year ended
31.3.2019 is Rs. 672 million and out of which, 76% represents the Maldives activity. For Maldives
activity certain building materials and workers are sent from Sri Lanka. The equity capital of the
company as at 31.3.2019 was Rs.8,500,000 (i.e. share capital + reserves). The profit and loss
account for the financial year ended 31.3.2019 and other related details are as follows:

Rs. 000’
Gross profit 201,600
Other income
Dividend received 4,300
Profit on disposal of motor vehicle 2,750
Administration Expenses ( Note 2) (148,035)
Selling & Distribution Expenses (Note 2) (16,660)
Net Finance income ( Note 1) 1,030
Net profit before tax 44,985

Note 1 – Net Finance Income

Finance Income Rs . 000’
Interest on fixed deposits (Net) 3,600
Interest on Treasury Bills 1,900
Finance cost
Interest on finance lease (1,120)
Interest on bank loan (3,350)
Net Finance income 1,030

Note 2 – Details of expenses

Administration Expenses Rs.000’
Salaries and Wages 104,200
ETF & EPF 15,077
Foreign travelling 995
Electricity 865
Provision for Gratuity - Note 3 3,500
Donations 600
NBT 13,400
Entertainment expenses 360
Depreciation 7,600
Advertisement 1,358
Total 148,035

8 CA Sri Lanka
 Selling & Distribution Expenses
Rs. 000’
Provision for bad & doubtful debt ( General) 1,480
Provision for bad & doubtful debit ( specific) 718
R&D 3,210
Vehicle maintenance 2,140
Travelling & transportation 9,112
Total 16,660

Note 3 - Details of Gratuity provision

Rs 000’
Provisions Balance as at 1 April 2018 13,490
Provision during the year 3,500
Payments (1,800)
Balance as at 31 March , 2019 15,190

Details of property, plant and equipment are as follows

Cost of Balance as Additions Disposals Balance as
Free hold at Rs Rs at 31.3.2019
01.04.2018 Rs
Rs .
Land 13,000,000 5,000,000 2,000,000 16,000,000
Building 19,000,000 4,000,000 - 23,000,000
Motor Vehicles 17,500,000 7,800,000 5,000,000 20,300,000
Office equipment 3,900,000 1,500,000 900,000 4,500,000
Plant & machinery 16,350,000 4,000,000 - 20,350,000
Furniture 4,500,000 1,500,000 - 6,000,000
Computer & equipment 4,320,000 1,200,000 - 5,520,000
Computer software 1,000,000 2,000,000 - 3,000,000
79,570,000 27,000,000 7,900,000 98,670,000
Lease Hold
Motor Vehicle Nil 6,500,000 - 6,500,000
79,570,000 33,500,000 7,900,000 105,170,000
Less : Depreciation
Building 9,500,000 1,900,000 - 11,400,000
Motor Vehicles 14,250,000 2,950,000 3,750,000 13,450,000
Office equipment 3,900,000 375,000 900,000 3,375,000
Plant & Machinery 16,350,000 1,000,000 - 17,350,000
Furniture 4,500,000 375,000 - 4,875,000
Computer and equipment 4,320,000 300,000 - 4,620,000
Computer Software 1,000,000 400,000 - 1,400,000
53,820,000 7,300,000 4,650,000 56,470,000
Lease hold
Motor Vehicle Nil 1,300,000 - 1,300,000
53,820,000 8,600,000 4,650,000 57,770,000
Net book value 25,750,000 47,400,000

CA Sri Lanka 9
Additional information
1. In addition to the book depreciation mentioned under the Administrative expenditure,
Rs 1,000,000 has been claimed under the construction service account.
2. The land used as a car park of the entity has been acquired by the government during the
year for road expansion project and paid a compensation of Rs. 7,500,000. The above new
land was purchased after 9 months of the acquisition (no any loss or gain recorded in this
transactions).
3. An old building has been purchased during the year amounting to Rs 4,000,000/- to use as
a place to store building materials and construction equipment to be used for construction
projects carried out in various places. A part of such materials are exported to Maldives
projects as well. A building with a value of Rs 5,000,000 was constructed for store
equipment and to use by workers during the year of assessment 2014/2015. Other buildings
were purchased by the company in 2008/2009.
4. A Motor lorry purchased in 2015/2016 has been disposed for a profit and included in the
accounts and the other lorry has been purchased for Rs. 7,000,000. A three-wheeler also
has been purchased during the year for Rs. 800,000 and used for transportation of materials
to sites. Two motor cars were purchased during Y/A 2016/2017 for Rs. 4,000,000 and
another car was purchased for Rs. 3,000,000 during the Y/A 2014/2015. All the others are
trucks used for transport of goods and workers to sites.
5. During the year two photocopiers included under office equipment was removed as those
were not in working condition and other two photocopiers were acquired for Rs 1,500,000.
Other office equipment were purchased by the company in 2011/2012
6. During the year the company has acquired locally made software for Rs. 2,000,000.
7. Motor lorry has been acquired from Wasana Leasing Lt d to pay 60 equal instalments of
Rs. 160,000 each and paid 8 instalments during the year.
8. If information has not been given for any type of asset, assume that those assets have been
acquired during the year of assessment 2010/2011.
9. During the year, the company carried out a research on alternate conditions of wetness and
dryness due to rain and sunshine, and the strength of the building and durability, to improve
the quality and the character of the construction of foundations and structural works. This
research has been carried out by a research institution in Sri Lanka and the cost of the
research is included in the total research expenditure of the company. An additional cost
of Rs 1,000,000 is also included under R&D expenditure incurred for advertising campaign
of the company in the construction field.
10. Donation represent Rs. 550,000 /- in cash to Victoria Home Rajagiriya , and the balance
is to a temple . There was a donation made by the company in 2017/2018 to the “Api
Wenuwen Api Fund” and there was a balance unclaimed Rs.150,000/-
11. Company obtained a loan from a bank and the loan balance stands Rs 32 million as at
31.3.2018
12. During the year ESC paid Rs. 3,000,000/-
13. The Maldives activities, the payment is received in foreign currency including the material
cost of the materials exported to Maldives. The material exported to the branch office is
included in the cost of construction and taken in to consideration in the calculation of the
gross profit.
14. Dividend received is after deducting the WHT.

10 CA Sri Lanka
 Answer

Ivory Construction (Pvt) Ltd

TIN …………
Year of Assessment 2018/2019
Computation of income tax for the year of assessment ended on 31.03.2019
Description Note Rs. Rs.
Business Income – Section 6
Profit before taxation 44,985,000
Add:
Book depreciation ( Note 2) 1 8,600,000
Assessable charge on sale of lorry 3 2,000,000
Entertainment expenses (Note 2) 360,000
Donation (Note 2) 6 600,000
R&D ( Note 2) 7 3,210,000
Advertisement (Note 2) 8 1,398,000
Gratuity (Note 3) 9 3,500,000
Bad debt provision ( general & specific) Note 3 10 2,198,000
Profit on disposal of land 12 5,000,000 19,477,000
64,462,000
Less:
Dividend received ( treated under investment income ) 2 4,300,000
Financial income (Note1) 5 1,030,000
Profit on disposal on motor vehicle (lorry) 3 2,750,000
Capital allowances 4 6,048,500
Finance charges 5 942,336
R&D ( Note 2) 7 4,420,000
Advertisement (Note 2) 8 2,398,000
Gratuity (Note 2) 9 1,800,000 (23,688,836)
40,773,164
Add : treasury bill interest ( effectively connected 5 1,900,000
with the business ( Note 1)
Assessable income from Business 42,673,164
Investment Income – section 7
Dividend income- Final income 2 - -
Interest on fixed deposits ( Note1 ) 5 3,790,000
Assessable income from Investment 3,790,000
Assessable income 46,463,164
Less : qualifying payments
Donation to an approved charity ( Note 2) 6 500,000
“Api Wenuwen Api Fund” 6 150,000 (650,000)
Taxable income 45,813,164
Applicable rate is 28% 12,827,686
Construction activities carried out in Maldives do not
fall under export of services as the services are done
outside Sri Lanka and not come under specified
CA Sri Lanka 11
 undertaking as well , further the construction services
represent only 76% of the total turnover , hence the
applicable rate is 28%
Less :WHT in Interest income 189,500
ESC 3,360,000 (3,549,500)
Tax payable 9,278,186

Notes
(1) Book depreciation Rs
Under administration expenses 7,600,000
Under construction expenses 1,000,000
8,600,000

(2) Dividend received

Tax has been paid, hence treated as final income [section 88(1)(a)].

(3) Disposal of motor vehicle

Rs
Cost of the lorry sold during the year 5,000,000
Accumulated book depreciation (3,750,000)
Net value 1,250,000
Profit from disposal (P&L) Added back 2,750,000
Sale price 4,000,000

Tax adjustment on the sale of motor vehicle

Rs
Cost 5,000,000
Capital allowances claimed from 2015/2016 , 2016/2017 & 2017/2018 @ 20% (3,000,000)
WDV as at 1.4.2018 2,000,000
Sale price 4,000,000
Assessable charge 2,000,000

(4) Capital allowances (additional information 1 to 8)

Rs Rs Rs
Building
Cost as at 1.4.2018 19,000,000
Less: building constructed in the Y/A (5,000,000) 333,500
2014/2015 @6 2/3 % ( 4th year claim)
Purchased buildings not entitled for capital 14,000,000 -
allowance
Only used factory buildings and hotel building
were entitled. Since the company provides
services purchased buildings prior to 1.4.2018
the capital allowances were not entitled
Additional building purchased during the year 4,000,000 200,000
Eligible for Capital allowance for 20 years
under Fourth Schedule 4,000,000/20
Total capital allowance for the buildings 533,500

12 CA Sri Lanka
 Motor vehicles
Cost as at 1.4.2018 17,500,000
Less : disposed during the year (5,000,000)
12,500,000
2 Motor cars - no capital allowance (7,000,000)
Balance vehicles are lorries 5,000,000 Fully
Purchased in 2010/2011 allowance claimed @ claimed
20% up to 2014/2015
Purchased during the year lorry Rs 7,000,000 7,800,000 1,560,000
– first year claim @ 1/5th & three wheeler Rs
800,000 used for transport of goods @ 1/5 =
Rs 1,400,000 + Rs 160,000
Lorry under finance lease – section 49(2) – 6,500,000 1,300,000
ownership transferred The cost is equal to Rs
6,500,000 – first year claim is equal to 1/5th of
the cost .
Total value of the finance lease Rs 9,600,000 (
Rs 160,000@60) hence total finance charge to
be spread over 60 instalments Rs 3,100,000 (
Rs 9,600,000 – Rs 6,500,000) . Financial
charge paid during the year is deductible
subject to thin capitalization rule under section
18. Financial charges for the year debited to
P&L account is Rs 1,120,000. ( financial
charges are not equally spread and this is a
blended loan as defined in section 31 ( capital
+ interest) . capital component is not claimable
as capital allowances are granted within 5 year
period
Total capital allowances on motor vehicle 2,860,000
Office equipment
Cost as at 1.4.2018 3,900,000
Less : disposed (900,000)
th
Acquired in 2011/2012 @121/2% (8 year 3,000,000 375,000
claim)
New purchases Rs. 1,500,000 claimable within 1,500,000 300,000
5 years
Total claim for office equipment 675,000
Plant and machinery
Cost as at 1.4.2018 16,350,000
Purchased in 2010/2011 (acquired prior to -
1.4.2011 ) rate was 25% ( for construction
equipment – fully claimed )
New plants & machinery Rs. 4,000,000 – 4,000,000 800,000 800,000
capital allowances 1/5 ( 5 years)
Furniture
Cost as at 1.4.2018 4,500,000 -
Purchased in 2010/2011 – capital allowances
@ 20% - fully claimed
CA Sri Lanka 13
 New furniture Rs 1,500,000 – capital 1,500,000 300,000 300,000
allowance 1/5 ( 5 years)
Computer equipment
Cost as at 1.4.2018 4,320,000 540,000
Purchased in 2010/2011 (prior to 1.4.2011 –
12.5% )
New purchased Rs 1,200,000 – capital 1,200,000 240,000
allowances -1/5 ( 5 years)
Total claim 780,000
Computer software
Cost as at 1.4.2018 1,000,000
Purchased in Y/A 2010/2011 fully claimed -
New purchase during the year Rs 2,000,000 is 2,000,000 100,000 100,000
an intangible asset. Since life time has not been
specified , it is assumed that it has an indefinite
useful life time 1/20
Total capital allowance 6,048,500

(5) Financial income (Note 1)

Rs
Interest on fixed deposit (investment income) gross up and WHT deducted 3,790,000
is allowed @5% (3600/95*100). However, it could also be argued (as
effectively connected with the business too if the mobilization advance
etc. are obtained for large construction projects etc. may deposit in fixed
deposit as well. ) In this case it is assumed as investment income

Interest on Treasury bills - Since this is sort term deposit and the business 1,900,000
is a construction company it is treated as effectively connected with the
business, hence part of the business income. No WHT applicable on
treasury bills
Financial charge (Note 1)
Rs
Interest on finance leasing ( Note (4) 1,120,000
Interest on bank loan 3,350,000
Total 4,470,000
Section 18 thin cap rule
The amount of financial cost deducted in ascertaining an entities from
conducting a business or investment for the Year of assessment shall not
exceed the amount of financial cost attributable to financial instruments
within the following limit
A*B , A= Rs 8,500,000 ( total of the issued share capital and reserves of
the entity )
B= 4 ( other than manufacturing)
Loan including financial lease ( since interest of financial leasing is also
included financial leasing balance is also part of the financial instrument
Rs 32,000,000+ 8,320,000 ( Rs 9,600,000 - 1,280,000) ( total lease –
lease payments during the year ) = Rs 40,320,000
Interest attributable = 4,470,000/ 40,320,000 = 0.11086
Interest restriction 0.11086* 8,500,000 = Rs 942,336 942,336
14 CA Sri Lanka
 Financial expenditure carried forwarded to be claimed in subsequent years 3,527,664
of assessments subject to the same restriction

(6) Donation (Note 2)

Rs
Disallowable in calculating the assessable income from business
However, qualifying payments are entitled through Fifth Schedule
is restricted to 1/5 of the assessable income or Rs 500,000
whichever is lower )
Donation to Victoria Home ( an approved charity for institutional 500,000
care for sick and needy) Rs 550,000/-
Donation to “Api Wenuwen Api Fund” is a government donation 150,000
and under transitional provisions any carried forward unabsorbed
qualifying payments can be carried forwarded and claimed after
1.4.2018
Qualifying payment for the Y/A 2018/2019 650,000
Total donation is disallowable but qualifying payment is allowable
as calculated above

(7) R&D ( Note 2)

Rs
The R&D expenditure for a research on alternate conditions of 3,210,000
wetness and dryness due to rain and sunshine, and the strength of the
building and durability, to improve the quality and the character of the
construction of foundations and structural works falls within the
definition of R&D under section 15 and double deduction is available
under paragraph (8) of the sixth Schedule , However, advertising
campaign is not R&D but deductible under advertisement
Less : advertising campaign (1,000,000)
2,210,000
Double deduction 4,420,000

(8) Advertisement ( Note 2)

Rs
Under administration expenses 1,398,000
Under R&D 1,000,000
2,398,000

(9) Gratuity ( Note 3)

Rs
Provision is not allowable but actual payment is allowed 1,800,000
Section 10

CA Sri Lanka 15
 (10) Provision for bad debts
Provisions are not allowable whether general provision or specific provisions (section 10).
Actual bad debts (if any) allowable subject to the provisions in section 24.

(11) Other deductions

Salaries & wages, EPF & ETF, foreign travelling (assume for business purposes),
electricity, NBT (assume as the correct amount for the year), vehicle maintenance &
travelling & transport expenses are treated as all allowable expenses.

(12) Disposal of land

Rs
Compensation received 7,500,000
Less : cost of the land 2,000,000
Profit 5,500,000
Spent on new purchase of land 5,000,000
Treated as expenses on the disposal since there is no profit or loss from 500,000
the transaction

Profit or loss for tax purposes

Since the land was used for business purposes the disposal is a realization
of a capital asset of the business under section 6(2)( c) of the Act (
effectively connected with the business ) . Hence the market value as at
30.9.2017 cannot be considered as it is applicable only for investment
assets . For the ascertainment of the profit cost is to deducted (section 37)
. Since the profit from the sale of the land has not been recognized as
income in the P & L account or the expenses incurred on the realization
has not been claimed in the P&L account, Rs. 500,000 is considered as
part of the cost under section 37 )
Sale price 7,500,000
Cost 2,000,000 + incidental expenses on the realization 500,000 (2,500,000)
Profit on sale of the land 5,000,000

(13) Disposal of photocopies

Rs
Cost 900,000
Less depreciation 900,000
Profit or loss NIL

16 CA Sri Lanka
 Question 3

Mixed activities (Hotel, garments for local and export market)

Lakmal (Pvt) Ltd is a company incorporated in Sri Lanka in year 2000. The
principal activities of the company are manufacture of garments to local market.
However, considerable amount of sales are made to exporters since the quality of the
garments are recognized as export quality. Apart from that, the company has a hotel in
Nuwara Eliya, named as “Nuwara Eliya Resort” which is mainly cater for foreign
tourists. Two separate accounts are prepared by the company for two businesses under the
name of Lakmal Ltd. You are provided with detailed accounts of Lakmal (Pvt) Ltd
based on the financial statement for the year ended 31,March 2019 , together with
supporting schedules which contained the following information.

(i) The assets based of the company as set out below:

- Plant & machinery acquired in January 2013 Rs 3,000,000 and in May 2016
for Rs 2,000,000
- Vehicles: - lorry acquired in July 2012 for delivery of garments Rs 5,000,000
- In March 2015 , Van used in the hotel for transport of goods
Rs. 2,000,000
- Motor car purchased in April 2017 Rs 3,000,000 used for official
travelling of the director
- Factory building constructed ( completed) in August 2016 Rs 10,000,000
- Hotel is carried on in a rented property annual rent is Rs. 3,600,000.
- Furniture for the hotel purchased in April 2017 Rs.1,000,000;
- Land purchased for the construction of a new factory in May 2017 for Rs.
15,000,000 and a parapet wall for constructed costing Rs. 150,000/- This was
not allowed by the Assistant Commissioner last year, hence the cost was
capitalized.

Assets acquired during the year are as follows:

- A new building is being constructed for the factory – Working progress as at
31.3.2018 Rs 10,000,000
- New machinery was purchased on June 1, 2018 for Rs 5,000,000.
- New machinery for the garment factory purchased in 2018 August for
Rs. 3,500,000
- A Machine for embroidery work was purchased in March 2019 for
Rs. 2,000,000/- but not used as it has a special operation , a technician
should be hired. Technician was employed in April 2019
- Motor car was purchased on December 2018 for office travelling Rs. 5,000,000
- New building was purchased for the hotel for Rs. 15,000,000 and shifted that
building on June 1, 2018.
- Lorry was purchased on Finance lease terms the agreement value is
Rs.3, 000,000 and payable in 48 monthly installments with interest starting
from January 2019. Interest for the year 2018/2019 was Rs. 500,000.
Capital allowances have been claimed up to the year of assessment 2017/2018 on
the assets eligible for claim.

CA Sri Lanka 17
 The following assets were sold during the year
- Old motor car was sold for Rs 3,200,000
- Land was sold due to financial difficulty For Rs. 18,000,000. Lawyer’s charges
and stamp duty on purchase not claimed for tax purposes Rs 250,000/-
- Machinery purchased in May 2016 was sold at Rs 500,000/-

(ii) Repairs and improvement

- Repair cost of the old machinery purchased in 2013 Rs. 50,000.
- The new machinery purchased in 2018 had a repair due to use of a machinery
over the capacity without following the instructions, The cost of repair was with
the replacement of certain parts of capital nature Rs. 2,000,000/-
- Repair of the factory constructed in 2016/2017 Rs 100,000/-
- A parquet flooring of the lobby of the new hotel cost Rs 200,000/-
- Normal repair expenses of the office building was Rs 40,000/-

(iii) Interest payment

Company has taken loans for the construction of the above buildings, Purchases of
assets and for other revenue nature expenses. The Share capital of the company is
Rs.10 mn , revenue reserves Rs. 2 mn and the total long term loans as at 31.3.2019
Rs 50mn.

(iv)Company has hired a consultant for the marketing strategy. He has worked in the
hotel for sometimes and taken short term loans payable to the hotel Rs 300,000/-
Company agreed to offset his loan instead of paying a salary for a year agreed at
Rs. 150,000/- That has not been accounted for.

(v) Company pays a royalty to the use of technology for garment factory software
package. Full payment was made and amortized on annual basis.

(vi)Company has a carried forward loss which was claimed subject to 35% of the total
statutory income up to 31.3.2018. The balance loss as at 1.4. 2018 is
Rs. 1,000,000/-

(vii) Entertainment expenses of the hotel include the foods provided to employees
too. The value is Rs 200,000/= which was taken as benefit from employment and
PAYE is deducted on that. The entertainment of the Garment factory is for
meal for customers taken from the hotel. It has been considered as a service
provided by the hotel and included in the turnover of the hotel. Director’s family
members come to the hotel once a month for dining. The value of the meal is Rs
50,000/- for each visit which has not been accounted for.

(viii) Company distributed dividends out of the dividends received of Rs 800,000/-

on which 10% WHT deducted in year of assessment 2017/2018.

(ix)WHT has been deducted at 5% on interest income

(x) Extra space of the factory is given to a company on rent which is used by the
company as a storage. Annual rent is Rs.1200,000/-
(xi)Gratuity opening and closing balances are equal.

18 CA Sri Lanka
Lakmal (Private) Limited
TIN : 123456789 0000
Detailed Income Statement - Year ended 31st March 2019 of the Garment business
Notes LKR

Revenue 1 1,000,000,000

Cost of sales 2 (500,000,000)

Gross profit 500,000,000

Distribution costs 3 (30,000,000)

Administrative expenses 4 (200,000,000)

Other operating income 5 80,000,000

Operating profit 350,000,000

Finance income 6 60,000,000

Profit before tax 410,000,000

1 Revenue
Sale of Garments to local market
200,000,000
Sale of garments to exporters
800,000,000

1,000,000,000
2 Cost of Sales
Gross salaries
150,000,000
Overtime
10,000,000
Travelling allowance
8,000,000
Bonus
10,000,000
EPF & ETF
22,500,000
Cost of the stock sold
127,000,000
Depreciation
75,000,000

CA Sri Lanka 19
 Royalties payable for the Y/A 2018/19

50,000,000

Repairs: Old Machinery Rs 50,000

New machinery Rs 2,000,000
Factory Rs 100,000
2,190,000
Other repairs to office building
Rs 40,000

Net Gain on Disposal of Fixed Assets & land

- car Rs 200,000
- land Rs 2,850,000 15,550,000
- Machinery Rs (1,500,000)
Factory consumables
1,000,000
Gratuity
6,000,000
Other expenses (allowable for tax purposes) 39,860,000

500,000,000
3 Distribution Cost
Promotional expenses (relates to fees received locally) 4,000,000
Advertisements 150,000
Entertainment 1,000,000
Donation 3,000,000
Bad debts written off 500,000
Other expenses including health insurance
provided to employees on equal basis (allowable
21,350,000
for tax purposes)
30,000,000
4 Administration Expenses
Electricity and gas expenses
30,000,000
Staff welfare
12,000,000
Postage & courier expenses
16,000,000
Staff Travelling and accommodation - local
20,000,000
Foreign travelling and accommodation
15,000,000
Printing and stationery
8,000,000
Bank loan interest
8,000,000
Telephone and fax and paging
6,000,000
20 CA Sri Lanka
 CEO's Vehicle lease rent
1,800,000
fuel for vehicles
2,000,000
Insurance premiums on travelling vehicle
100,000
Insurance premiums on Professional & General Liability
1,500,000
Transport costs
12,000,000
Bank charges
2,000,000
Staff training
400,000
Water
1,500,000
Audit and professional fees
1,200,000
Other cost of production deductible 22,000,000
Other expenses (allowable for tax purposes)
40,500,000

200,000,000
5 Other Operating income

Expenses reimbursed by clients 80,000,000

80,000,000
6 Finance Income

Interest Income - FCBU (Gross) 3,000,000

Interest Income - Fixed Deposit (Gross) 1,000,000

Dividends 1,000,000
Rent income 1,000,000

6,000,000

CA Sri Lanka 21
Lakmal (Private) Limited
TIN : 123456789 0000
Detailed Income Statement - Year ended 31 March 2019 of the Hotel business
Notes LKR
Revenue 1 50,000,000
Cost of sales 2 ( 10,000,000)
Gross profit 40,000,000
Operating expenses 3 ( 5, 000,000)
Administrative expenses 4 ( 8,300,000)
Finance income 6 1,000,000
Profit before tax 27,700,000
2 Cost of sales
Foods purchases 4,000,000
Preparation charges 2,000,000
Kitchen usage cost 1,000,000
Cutlery 2,000,000
Other direct cost 1,000,000
10,000,000
3 Operating expenses
Entertainment 1,000,000
Advertisements 2,000,000
Other allowable expenses 2,000,000
5,000,000
4 Administrative expenses
Stationary and janitorial services 4,000,000
Repair expenses - Hotel flooring 200,000
Hotel rent 600,000
Staff salary 1,000,000
Depreciation 500,000
Health insurance of the staff provided equal
basis 1,000,000
Other allowable expenses 1,000,000
8,300,000
6 Finance income
Interest income (gross) 1000,000

22 CA Sri Lanka
Answer

Lakmal (Pvt) Ltd

TIN …………
Year of Assessment 2018/2019
Computation of Income Tax
Based on the statutory accounts for the year ended 31.3.2019
Description Schedule LKR
Profit before taxation of the manufacturing sector 410,000,000
Add:
Book Deprecation 1 75,000,000
Repairs 3 2,190,000
Entertainment 5 1,000,000
Donation – Note 5 3,000,000
Interest 4 8,000,000
499,190,000
Less :
Net gain on disposal of fixed assets & land 2 1,550,000
Dividends 6 1,000,000
Rent income 7 1,000,000
Interest income 7 4,000,000
491,640,000

Profit before taxation of the hotel sector 27,700,000

Add:
Director’s dining 5 600,000
Entertainment 5 1,000,000
Repairs 3 200,000
Depreciation 1 500,000
521,640,000
Disposal of assets
Profit from sale of the car 2 200,000
Profit on sale of the land 2 2,600,000
524,440,000
Less :
Capital allowances 1 3,750,000
Interest income 7 1,000,000
Balancing Allowance on disposal of machinery 2 166,666
Repair expenses 3 190,000
Interest expenditure 4 5,760,000
Employees meal expenses ( entertainment) 5 200,000
Consultancy fee - Note 11 150,000
513,223,334
Other business income :
Rent income 7 1,200,000
Interest income 7 5,000,000
Adjusted profit / Assessable income 519,423,334
Less : Loss carried forward 1,000,000
CA Sri Lanka 23
 Taxable profit 518,423,334
Tax payable @ 28% 145,158,533
Less : credit for WHT
On rent income 100,000 8
Interest income 250,000 350,000

Balance payable 144,808,533

Less Self-assessment payments XXXXXX

Schedules
1. Capital allowances
1.1 on assets purchased for the period prior to April 1, 2018
Description Year of Cost Rate Amount Remarks
assessment
Land
Land 2017/2018 15,000,000 Not a depreciable
asset
Add : Parapet wall 150,000 - - Sold in 2018/2019
- Schedule 2
Building
Factory building 2016/2017 10,000,000 10% 100,000 3rd, year
constructed
Plant & Machinery
Machinery 2012/2013 3,000,000 331/3% - Fully claimed

Machinery 2016/2017 2,000,000 331/3% - Sold during the

year.
Vehicles
Lorry 2012/2013 5,000,000 20% Fully claimed
Van 2014/2015 2,000,000 20% 4,00,000 6th year
Car 2017/2018 3,000,000 - - Used for travelling.
Not claimable. sold
during the year –
Schedule 2
Furniture 2017/2018 1,000,000 20% 200,000 2nd year
Total 700,000

1.2 On assets purchased on or after April 1, 2018

Description Year Cost Depreciation No Depreciation Cumulativ WDV Remarks
LKR base of for the year e LKR
LKR year LKR Depreciati
s on LKR
Building
Purchased 2018/ 15,000,000 15,000,000 20 750,000 750,000 14,250,000 Section 14 &
Flooring 2019 200,000 Forth Schedule
Construction 10,000,000 10,000,000 - - - 10,000,000 Section 16
working Not claimable
progress as the
construction is
not completed
to be used
Machinery
24 CA Sri Lanka
Machinery 2018/ 3,500,000 3,500,000 5 700,000 700,000 2,800,000 Forth Schedule
2019 2,000,000 & section 16 (2)
Repair cost not
deductible since
there is no
WDV as at
31.3.2018 (
section 14 &
Forth Schedule
)
Machinery 2018/ 5,000,000 5,000,000 5 1,000,000 1,000,000 4,000,000 Forth Schedule
2019 & section 16 (2)
Machinery 2019/ 2,000,000 2000,000 - - - 2,000,000 Not used -
2020 section 16(2)
Vehicles
Lorry 2018/ 3,000,000 3,000,000 5 600,000 6,00,000 2,400,000 Section 31,
Note 12 2019 Forth Schedule
& 16(2)
Car 2018/ 5,000,000 5,000,000 - - - - Not a
2019 commercial
vehicle
( Forth
Schedule)
Total 3,050,000
Capital allowances for the year Rs 3,050,000+ 700,000 = 3,750,000
2. Gain/ profit on disposal of assets
Description Year of Cost LKR Capital Tax Sale Taxable profit /Loss or
purchased allowances WDV proceeds Balancing allowance or
claimed LKR LKR assessable charge
LKR LKR
Motor car 2017/2018 3,000,000 N/A - 3,200,000 200,000 business profit [ sale
of a depreciable asset Section
6(2)(d) ]

Land 2017/2018 15,000,000 N/A - 18,000,000 2,600,000 [sale of a capital

Add : cost on 250,000 asset a business profit , the cost
purchase & 150,000 is the historical cost but
construction of 15,400,000 expenses not claimed for tax
parapet wall purposes could be added to the
cost ( sections 6(2)(c) & cost
is calculated as per section 37]
Machinery 2016/2017 2,000,000 1333334 666,666 500,000 166,666 (Balancing allowance)
Section 16(1)(b) & Forth
Schedule

3. Repairs
Description Amount LKR Remarks
Repair of old machinery 50,000 Claimable under section 11
New machinery 2,000,000 - Not claimable under section 14 since there is no
WDV at the end of the previous year ,Hence added
to the WDV of this year as the base for capital
allowances for the next year onward ( section 14 &
Forth Schedule )
Factory repairs 100,000 100,000 Factory was constructed prior to 1.4.2018, hence
section 14 is not applicable. Section 11 will apply
for deduction. General repair expenses are
CA Sri Lanka 25
 permitted to be deducted
Flooring for the new hotel 200,000 - Section 14 is applicable. Since the construction was
completed during the year, there is no WDV at the
end of the previous year. Hence the deduction is not
permitted, but added to the depreciation base
(WDV at the end of the year and capital allowances
could be claimed from the next year.
Repair expenses of the office - 40,000 Allowable ( section 11)
building
Total claimable 190,000 Allowable for tax purposes

4. Interest deduction –Application of section 12 ( normal interest deduction rule ) & section 18 (Thin
capitalization rule )
Interest debited to the P&L account Rs. 8,000,000 (assume that the interest on leasing of the lorry
Rs. 500,000 is included in the total interest) –allowable subject to the restriction under section 18.

Section 18 restriction:
Share capital and reserves Rs 10m + Rs 12m = A
2mn
Since the company is a B= 3 12x3 = 36
manufacturing entity
Loans Rs 50 mn
Allowable deduction 8/50x36 Rs 5.76 mn
Since the P&L charge is more than the allowable
deduction the excess can be carried forwarded. The
carried forward interest for this year is Rs 2.24 mn which
is deductible in six subsequent years of assessments.
5. Entertainment
(i) Disallowable in full (section 10) However, meals provided to employees of
Rs. 200,000/- is not treated as entertainment as the benefit from employment is
taxed for PAYE .
(ii) A meal provided to customers from the hotel has taken as income of the hotel. But
still expenditure is disallowed as it is an entertainment cost. ( section 10)
(iii) Directors personal meal cost is to be accounted for as revenue of the hotel.
( section 195 – definition of payment) Added back Rs 50,000x12 = 600,000/-

6. A dividend on which WHT is deducted is exempt from income tax. The dividend tax has been
deducted in the Year of assessment 2017/2018. Such dividend is deemed to be tax deducted
dividends as per item 11 of the regulation under Gazette no 2064/53 dated 1.4.2018

7. Rent income – Annual rent is Rs. 1,200,000/ - only Rs 1,000,000 has been accounted for.
However, full rent accrued for the year is liable for Income tax. Since it has been given to be
used as a business premises WHT is deducted at 10% on the rent received Rs. 100,000/-
Effectively connected with the business .

26 CA Sri Lanka
8. WHT :
- on rent received ( Rs 1,000,000 @ 10% ) Rs. 100,000
- on Dividends ( Rs 1,000,000 @ 14% Rs 140,000) Not deductible
- Interest income ( FCBU Rs 3,000,000 + Fixed Deposits Rs 1,000,000 + Hotel sector –
Fixed deposits Rs 1,000,000) Rs 5,000,000 @5% = Rs 250,000 = Rs 350,000 [First
Schedule , section 2(3)(c)] .

Notes (assumptions/ explanations)

1. EPF & ETF – Assumed the amount claimed is the accrued amount for the period.
2. Cost of stock sold - Assumed this is calculated as per section 13 & section 42 of the IR
Act No 24 of 2018
3. Royalty payment claimed out of the total payment is the attributable part for the year .
4. Gratuity provision is not allowable but the actual payment for the year is allowable. Since
both the opening and closing balances are equal payment is equal to the provision during
the year.
5. Donation is not allowable as it is not incurred in the production of income
6. Assume that Staff welfare does not include any disallowable expenses
7. Assume foreign traveling and accommodation are related to business expenses
8. CEO’s vehicle lease rent has been taken as employment benefit and PAYE is deducted
9. Interest on fixed deposits forms part of the business income and WHT deducted is
allowable as a deduction
10. Hotel rent – From June 1, 2018, hotel is carried out in the new building purchased.
Hence the rent payment is only for the months of April and May, 2018. Annual rent is
Rs. 3.6mn and therefore, for the two months Rs. 600,000/-
11. Consultant’s fee – Rs . 150,000/ is an expenditure and deductible under section 11
12. Leasing of the lorry – section 31 – lessee is entitled to claim capital allowances and the
interest is claimable too. Hence the total Agreement value should be split as capital part
and interest part. Capital part is subject to capital allowances and the interest is
deductible. Lessor cannot claim capital allowances on assets under finance leases
entered into on or after 1.4.2018..
13. Loss carried forward- as per item 5 of the transitional provisions gazette no 2064/53
dated 1.4.2018, eligible loss to be carried forward under the IRD Act No 10 of 2006, is
deemed to be a loss deductible from the assessable income for any year of assessment
commencing from 1.4.2018. As such, the loss carried forward is deductible under section
19 of the Act No 24 of 2017, for a period of 6 years. Under section 19, loss could be
deducted from the same source of income, however, carried forward loss cannot be
identified separately as it is a balance of a composite loss and further the applicable rate
in this case is 28%, since the company is not eligible to apply any concessionary rates as
explained in note 14.

CA Sri Lanka 27
 14. Application of tax rate : Export turnover Rs 800,000,000
Other local sales Rs 200,000,000
Interest income FCBU 3,000,000
FD 1,000,000
Dividends 1,000,000
Rent income 1,200,000
Hotel turnover 50,600,000
Interest 1,000,000
257,800,000
% of export turnover 800,000,000/1057, 800,000*100= 75.63% Less than 80%, hence the
concessionary rate is not applicable. Applicable rate is 28%

15. Interest income and rent income are also treated as business profits and the rate is also the
28%.

28 CA Sri Lanka
 Management of Value-Added Tax (VAT)

- Question 1 - provision of management services and other connected services ( DIRHL )

- Question 2 - Construction Industry (DIRCL)
- Question 3 – manufacturing and export including local supplies. ( mixed supply) (DIREL)

Computation of VAT
DI Ridge Holding Ltd (DIRHL) is a holding company manages its activities through two companies
namely DI Ridge Construction Ltd (DIRCL) and DI Ridge Export Ltd (DIREL) which are
incorporated in Sri Lanka and there is an associated company of the group registered in India named
DI Ridge Services Ltd (DIRSL –India) incorporated under the domestic laws of India. The activities
of the companies are as follows:
DIRHL is the holding company manages the other company which provides management services and
other administrative functions of the group. In addition to that company provides financial assistances
to the group in case where there the necessity arises, carries out market Research, advertisement
functions and negotiation of contracts on behalf of the group companies. There are other management
activities too carries out by the company in a small way.
DIRCL carries out construction projects in Sri Lanka and Maldives. In Maldives a branch office is
established by DIRCL and presently in the process of completing two hotel projects. Since there is no
Double Taxation Agreement in force with Sri Lanka and Maldives the tax in Maldives on the profit
attributable to the Permanent Establishment (PE) in Maldives is paid in that country and also subject to
tax in Sri Lanka under the domestic law in Sri Lanka. DIRCL does certain construction projects in India
as well to DIRSL – India.
DIREL is established mainly to carry out manufacturing and export activities and providing the services
to foreign customers. In addition DIREL supplies goods and services to local customers including
DIRCL.
DIRSL – India - also carries on construction projects in India, 75% of the shares of the DIRSL is held
by DIRHL. goods and services for most of the construction work is exported to DIRSL by DIREL and
also certain construction services are carried out in India by DIRCL as well.
All three Sri Lankan companies are registered for VAT. The detail transactions of three companies have
been provided to you by the finance manager of the group since you are the tax advisor of the group
who is responsible in filing returns and to advise the group on the specific tax matters that they have
raised.

CA Sri Lanka 29
 Question 1
DIRHL - the returns are filed on quarterly basis and the following transactions have been extracted
from the books for the period ended 30.09.2019. The amounts given here are excluding VAT and where
applicable VAT is charged.
Supplies:
- Management services to group companies
- DIRCL was invoiced for the period Rs. 30,000,000 /- the period covered 3 months
but DIRCL has settled only for two months and the payment for the month of
September 2019 is outstanding. The amount outstanding is Rs. 10,000,000/- .
In addition to that DIRHL is responsible in managing the Maldives branch of
DIRCL and the management functions are carried out by DIRHL online without
visiting the branch physically. The monthly management fee is agreed
upon at Rs 5,000,000/- three months fee was collected from DIRCL on behalf
of the foreign branch.
- The management fee for DIREL was Rs. 10,000,000 per month and since DIREL
is registered for monthly basis being an exporter the invoice for the period covering
the months (June, July & September was issued on 30th September 2019.) DIREL
is registered within SVAT Scheme as RIP (Registered Identified Purchaser).
DIRHL received a voucher for VAT component suspending VAT. DIRHL is
registered in the SVAT Scheme as a RIS.
- Dividend income received Rs. 4,000,000.
- Loan interest on temporary loan facilities granted to DIREL Rs. 1,000,000 and
to DIRCL Rs 2,000,000. Interest on loan given to DIRSL – India
Rs. 10,000,000 ( converted in to Sri Lanka rupees)
- Sale of a motor vehicle used for traveling purposes Rs 10,000,000/- This
was purchased from a vehicle dealer on 1.1.2015 for Rs. 8,000,000/-
- Sale of old computers Rs. 5,000,000/- , two computers were given to employees
as those were outdated. The book value at the time of such disposal was
Rs. 500,000/- and the company purchased new computers for Rs. 10,000,000.
- Company purchased a land in 2002 for Rs. 10,000,000 and constructed an
office building during the period from 2005 to 2006 and the building was
completed with the cost of Rs. 25,000,000/- . for which VAT paid to the
contractor . Since the space is not enough company shifted to a new building
which was purchased on lease basis for the term of 99 years. Total value of the
lease period was paid as one payment Rs. 60,000,000/- land value is Rs
5,000,000/- was paid separately. Owner is an individual used this property as an
investment asset and not registered for VAT. The old building was sold for Rs.
40,000,000/- the market value of the land at the time of sale was Rs. 25,000,000.
Company has rented out two floors of the new building to DIREL to store
merchandise delivered from that place. Monthly rent was Rs. 1,000,000/- starting
from the month of July 2019. All the transaction with DIREL were done with
suspended invoices.
- Advertisement services
- invoiced to DIREL Rs 1,500,000
- Invoiced to DIRCL Rs. 1,090,000
- Special advertisement for foreign construction services for the branch
office in Maldives invoiced to DIRCL Rs. 1,000,000. The payment was
made to webpage through internet service company outside Sri Lanka
which is an online using the space.

30 CA Sri Lanka
 - Employment services. DIRHL provides employees whose salaries are paid through
the DIRHL pay sheet and hired to DIRCL local office and to Maldives branch. The
salary is reimbursed through the local company.
Salary reimbursed by DIRCL Rs.15,000,000 out of which Rs.5,000,000 is on
behalf of the branch office

Expenses:
Local purchases and expenses –
- Telephone bills and internet usage Rs. 3,000,000/-
- Water bills Rs.300,000
- Electricity Rs.450,000
- Salaries to employees Rs.25,000,000

Other purchases from VAT registered persons

- Payment to advertising design services Rs. 5,000,000/-
- Vehicle hiring company for vehicle use for office travelling Rs.500,000/-
- Research institution Rs. 350,000/-
- Other expenses liable to VAT Rs.5,600,000/-
- Motor vehicle expenses used for travelling ( repairs and service charged)
Rs. 500,000/-
- Catering service for managing director’s personal function to the office
staff Rs. 190,000/-

Purchases from non VAT registered persons

- Stationery Rs. 350,000/-
- Office equipment Rs.310,000
Carried forward unabsorbed input credit Rs. 650,950/-
VAT paid under self-assessment basis Rs.300,000/-

Required :
(i) Calculate the VAT payable (refund ) if any for the taxable period ended
30. 9. 2019 ( 8 marks )
(ii) You should provide notes explaining the following :
- Calculation of disallowable input tax (input disallowable in full & disallowable input
on proportionate basis on exempt supplies with your reasons.) ( 3 marks)
- Calculation of carried forward unabsorbed input credit (if any) (2 marks)
- Calculation of VAT liability on sale of property ( 2 marks)
- Explain the VAT implications on the supply of goods or services to Maldives
(2 marks)
- Company request your advice on the following: ( 8 marks)
- Whether the monthly returns could be submitted instead of quarterly
returns since they have to pay two payment instalments which would
miss-match with actual payments;
- Whether instalment payments could be paid monthly rather than paying
twice a month ;
- Since the company provides services to overseas branch and to the Indian
subsidiary and also to a SVAT registered RIP whether the present
registration as an RIS could be extended to cover RIP status as well.

CA Sri Lanka 31
 Question 2

DIRCL – DIRCL is presently engaged in several local construction projects in addition to the two
hotel projects carried out in Maldives. Further one construction project is being completed in India
which is done through their associated company DIRSL – India and for a new building structural
plan and the other connected main designing work part is done by DIRCL. Such services are carried
out in Sri Lanka but for the construction work the workers and civil engineers are sent to India and
Maldives time to time. DIRCL has obtained the approval under section 23 of the Act to account
for VAT purposes on cash basis. The following transactions were extracted from the books for the
period ended 30.09.2019. The amounts given here are excluding VAT and where applicable VAT
is charged.
Supplies (Company issue Performa invoices until the payments are made as advised by the
tax advisor):
- Local contracts invoiced for the period of July Rs 300,000,000/- August Rs 254,000,000/- and
for September Rs 210,000,000/- Out of which payments received for the invoices raised in July
and certain invoices raised in April , and May amounting to Rs 400,000,000/-

- New contract was signed with the Government Department and the work started in October 2019,
However, in the month of September mobilization advance was received Rs 200,000,000/-

- A retainer fee of the contract completed in January 2019 was received in August Rs. 10,000,000/-

- Design work done in Sri Lanka for Indian company Rs. 120,000,000/- invoice was raised on
September but payment is still pending , whereas , the construction work carried out in India during
the last 6 months period was paid for which invoices were issued in the last quarter. The amount is
Rs. 124,000,000 ( converted in to Sri Lanka Rupees)
- Work done in Maldives was invoices for Rs 200,000,000/- (converted in to SL Rupees) but out of
which only Rs 100,000,000/- was received. For the new hotel project advance received from
Maldives Rs. 300,000,000/-
- Materials exported to Maldives for the project done by the company Rs 100,000,000/-
- Materials exported to DIRSL – India to be used in the Indian project Rs 200,000,000/-
Payment received for both in foreign currency

Expenses
Imports :
- bathroom fittings and equipment were imported for the local construction project which is a
turnkey project . The CIF value is Rs 100,000,000, Custom duty Rs 40,000,000/- , PAL
Rs. 7.000,000 and VAT and NBT charged at the point of Customs.
- Fitting imported for the Managing directors new house through company account CIF value
Rs 5,000,000 , Customs duty Rs. 500,0000, PAL Rs. 350,000/- and VAT and NBT charged.

Local purchases of goods and services

- Building materials purchased from DIREL Rs 200,000,000 but payment made in October 20,
2019
- Payments made for materials purchased from VAT registered persons Rs. 315,000,000 for which
invoices received in June 2019. Out of such purchases partly exported to Maldives for the
construction work done there. Since it is a branch office of the company no mark-up added.

32 CA Sri Lanka
 - Management services received from DIRHL for the period was Rs. 30,000,000 /- (covered 3
months) but settled only for two months and the payment for the month of September 2019 is
outstanding. The amount outstanding is Rs.10,000,000/- .
- In addition to that DIRHL is responsible in managing the Maldives branch of DIRCL and the
management functions are carried out by DIRHL online without visiting the branch physically. The
monthly management fee is agreed upon at Rs. 5,000,000/- three months fee was paid to DIRHL
on behalf of the foreign branch.
- Payments for the services provided by DIREL from Sri Lanka on construction activity of the
Maldives branch Rs. 20,000,000
- Interest on loan taken from DIRHL Rs. 2,000,000.
- Advertisement services invoiced by DIRHL Rs. 1,090,000/- total amount was paid and Special
advertisement for foreign construction services for the branch office in Maldives invoiced by
DIRHL Rs. 1,000,000. The payment was made to webpage through internet service company
outside Sri Lanka which is an online using the space.
- Employment services. DIRHL provides employees whose salaries are paid through the DIRHL pay
sheet and hired to DIRCL local office and to Maldives branch. The salary is reimbursed through
the local company.
Salary reimbursed by DIRCL Rs Rs. 15,000,000 out of which Rs.5,000,000 is on behalf of the
branch office

Other Expenses:
Local purchases and expenses ( all paid) –
- Telephone bills and internet usage Rs. 1,200,000/-
- Water bills Rs. 100,000
- Electricity Rs. 450,000

Carried forward unabsorbed input credit Rs. 230,000/-

VAT paid under self-assessment basis Rs. 300,000/-

Required :
(i) Calculate the VAT payable (refund ) if any for the taxable period ended 30. 9. 2019 ( 10 marks )

(ii) You should provide notes explaining the following :

- Calculation of disallowable input tax (input disallowable in full & disallowable input
on proportionate basis on exempt supplies with your reasons.) ( 3 marks)
- Calculation of carried forward unabsorbed input credit (if any) (2 marks)
- Explain the VAT implications on the supply of goods or services to Maldives and
India ( 5 marks)
- Company request your advice on the following: ( 5 marks)
Presently DIRCL conduct to construction projects in Maldives through a branch
established there. Company request your opinion whether they could start a
company in Maldives instead of having a branch office (PE) and what are the
advantages they could get for VAT.

(iii) Explain the legal provisions in the VAT Act, under cash basis accounting for VAT (the time of
supply rule and the issue of Tax invoices) as the company issues Performa invoices based on your
advice.)

CA Sri Lanka 33
 Question 3
DIREL is established mainly to carry out export activities and providing the services to foreign
customers. In addition DIREL provides goods and services to local customers including DIRCL as well.
The building materials are manufactured by the company to be supplied to foreign companies and also
to RIPs who carry out construction work during the project implementation period registered under
section 22(7) of the VAT Act and under section 3(4) the Strategic Development Project Act and obtained
RIP status under SVAT scheme for VAT suspension. DIREL is registered under monthly taxable period
within the provisions of the VAT Act and obtained both RIP status.
The following transactions have been extracted from the books for the period ended 30.09.2019. The
amounts given here are excluding VAT and where applicable VAT is charged.
Supplies:
Goods:
- Building Materials exported to DIRSL –India Rs. 150,000,000 to be used in the
construction projects carried out
- Building materials supplied to DIRCL Rs. 200,000,000/-
- Supplies of building materials to Strategic Development projects during the project
implementation period who are registered as RIPs Rs. 300,000,000
- Supplies to VAT registered persons Rs 130,000,000/=
- Supplies to customers not registered for VAT Rs.345,000,000
Services:
- Advice on Structural work and designs to Maldives projects Rs.20,000,000 paid by
DIRCL in rupees
- Services to SDP projects registered during the project period under SVAT Rs 25,000,000
- Online services relating to construction work done by DIRSL – India Rs. 300,000,000
( converted to rupee value )
- Sale of a construction machinery Rs 10,000,000, this was imported from China, 3 years
back and VAT on importation was claimed .
- Supply of locally purchased building materials to SVAT registered companies during
the project implementation period Rs. 254,000,000
- Supply of imported materials to SDP projects Rs. 10,000,000
Expenses :
Imports :
- Raw material imported CIF value Rs. 29,000,000, Custom duty, PAL and NBT exempted
and VAT is deferred.
- Finished materials imported to be supplied to RIPs CIF value Rs 30,250,000/- Customs
duty Rs. 6,500,000, PAL Rs. 2,100,000/- NBT and VAT is charged.

Local purchases of goods and services

SVAT purchases
- The management fee paid to DIRHL was Rs. 10,000,000 per month and since DIREL is
registered for month basis, the invoice for the period covering the months (June, July &
September was issued on 30th September 2019.)
- Building rent paid to DIRHL from the month Rs. 1,000,000/-
- Advertisement services - paid to DIRHL Rs. 1,500,000
- Purchase of building materials locally Rs. 30,000,000
- Telephone bills Rs. 130,000/-
34 CA Sri Lanka
 - Company provide meals to workers and the supply was outsourced. payments to meal
suppliers Rs 2,000,000

Purchases from persons registered for VAT but not registered for SVAT
- Equipment for the factory Rs 12,000,000/-
- Water filters Rs. 2,000,000/-
- Car hiring fee Rs. 100,000/-
- Stationery Rs. 3,000,000
- Furniture for the office Rs. 12,000,000
- Security services Rs. 2 ,000,000
-
Purchases form persons not registered for VAT
- Janitorial services Rs. 200,000
- General office purchase Rs 1,000,000
- Fertilizer for the garden plants Rs 200,000

Loan interest on temporary loan facilities granted by DIRHL Rs. 1,000,000 .

Carried forward unabsorbed input credit from last month Rs 200,000
Company has not paid self-assessment payment considering the unabsorbed VAT

Required :

(i) Calculate the VAT payable (refund ) if any for the taxable period ended 30. 9 2019
( 10 marks )
(ii) You should provide notes explaining the following :
- Calculation of disallowable input tax (input disallowable in full & disallowable input
on proportionate basis on exempt supplies with your reasons.) ( 3 marks)
- Calculation of carried forward unabsorbed input credit (if any) (2 marks)
- Explain the VAT implications on the supply of goods or services to Maldives and
India ( 5 marks)
- Company request your advice on the following: ( 5 marks)
- Whether the company could obtained deferment facility on the
importation of building materials supplied to SVAT registered RIPs
without further production process
- VAT implication on the related party transactions

CA Sri Lanka 35
Suggested Answer
Question 1
DI Ridge Holding Ltd (DIRHL)
Computation of VAT liability for the taxable period ended on September 30,2019

Output Value of Rate VAT Rs

supply (Rs)
Management services to group companies
- Services billed to DIRCL - 30,000,000 15% 4,500,000
the period covered 3 months but DIRCL has
settled only for two months and the payment for
the month of September 2019 is outstanding. The
amount outstanding is Rs 10,000,000/-
[ liability arises on accrued basis since the invoice was
issued irrespective of the facts that the full payment was
not made – section 4(1)]
- Maldives branch of DIRCL and the management 15,000,000 Exempt -
functions are carried out by DIRHL online without
visiting the branch physically. Rs. 5,000,000* 3
[ the service is provided in Sri Lanka to be utilized outside
Sri Lanka which is zero rated under section 7(c) , however,
the payment is received in Sri Lanka rupees from DIRCL ,
hence not zero rated but exempt from VAT under item (vi)
of paragraph (b) of PART II of the First Schedule to the
VAT Act]
- Management services to DIREL Rs. 10,000,000 30,000,000 15% 4,500,000*
per month and the invoice was for the period
covering the months (June, July & September was
issued on 30th September 2019.)
[ VAT is suspended since DIREL is registered as RIP
under SVAT Scheme – section 2(2)(e), credit vouchers
were received and the credit will be given through the
system.]
Dividend income received 4,000,000 Not a VAT -
( not treated as financial service as well since the company supply
is not a specified institution for the provision of Financial
services – section 25(C)(5)(f)]
Loan interest on temporary loan facilities to group 13,000,000 Not a VAT -
companies supply
- DIREL Rs. 1,000,000
- DIRCL Rs 2,000,000
- DIRSL – India Rs. 10,000,000
(not a VAT supply and further not liable to VAT on
financial service either, since the supply of loan facilities
to the group companies is excluded from the supply of
financial services unless the company is formed to supply
such facility. DIRHL is a management company and not
established to provide financial services – section 25C
(5)(d)] .
Sale of a motor vehicle used for traveling purposes Rs 10,000,000 Exempt -
10,000,000/-
36 CA Sri Lanka
 [Paragraph (I) of PART II of the First Schedule, w.e.f
25.10. 2014 , motor vehicles were exempted from VAT
including the unsold vehicles by vehicle dealers . Since the
vehicle was purchased from a vehicle dealer it was exempt
at the time of purchase. hence the disposal of an exempt
asset not liable to VAT as the exemption continues at the
time of sale too]

Sale of old computers Rs. 5,000,000 and, two computers 5,500,000 Exempt -
were given to employees as those were outdated. The book
value at the time of such disposal was Rs. 500,000/-
[ supply to employees is a benefit from employment but the
supply is an exempt supply , hence there is no deemed
liability – item (xii) of paragraph (a) of PART II of the
First Schedule]
Sale of land and building (Note 1) 15,000,000 15% 2,250,000

Rent income from DIREL Rs 1,000,000 @3 (July, August 3,000,000 15% 450,000*
& September )
Payment is made through SVAT, hence VAT is
suspended.
Advertising service 1,500,000 15% 225,000*
- invoiced to DIREL Rs 1,500,000 ( SVAT payment)
- Invoiced to DIRCL Rs. 1,090,000
- Special advertisement for foreign construction 1,090,000 15% 163,500
services for the branch office in Maldives invoiced
to DIRCL Rs. 1,000,000. The payment was made to 1.000.000 15% 150,000
webpage through internet service company outside
Sri Lanka which is an online using the space. Note 2
Employment services. Note 3
- Services provided to DIRCL 10.000,000 15% 1,500,000
- Services to Maldives for payments by DIRCL 5,000,000 Exempt/ -
excluded
Total 144,090,000 13,738,500
Input tax
Imports : No imports -
Local Purchases
Computers 10,000,000 Exempt
Telephone bills and internet usage 3,000,000 450,000
Water bills 300,000 45,000
Electricity 450,000 Exempt
Salaries to employees 25,000,000 No VAT
Payment to advertising design services 5.000,000 750,000
Vehicle hiring company for vehicle use for office 500,000 75,000
travelling
Research institution 350,000 52500
Other expenses liable to VAT ( assume not common 5,600,000 840,000
expenses )
Catering service for the opening function of the new 190,000 28,500
office
Motor vehicle expenses ( repairs and service charged) 500,000 75,000
Purchases from non VAT registered persons 350,000 No VAT
CA Sri Lanka 37
 Stationery
Office equipment 310,000 No VAT
Total input 2,316,000
Disallowable input tax - Note 4 (705,123))
Allowable input tax 1,610,877
Carried forward unabsorbed input credit 650,950 650,950
Total allowable input tax including Carried forward 2,261,827
Carried forward input tax ( if any) Note 5
Input tax does exceed the output tax declared , hence no
carried forward
VAT payable 11,476,673
Less : SVAT credit vouchers ( 4,500,000+ 450,000_ (5,175,000)
225,000)
VAT paid under self-assessment basis (300,000)
6,001,673

Note 1- sale of land and building

Sale price Rs 40,000,000
Less Market value of land at the time of sale Rs. 25,000,000
Value of supply under section 5(7) 15,000,000
No adjustment for input tax on construction for this period since that would have been already claimed in
the year of construction.
New land purchased Rs 60,000,000 from an individual not registered for VAT and since the period of
ownership more than 50 years under the Inland Revenue Act [section 48(2)], the ownership passes to the
Company and a capital gain to the seller. Hence no VAT collected on purchase and therefore, no input tax
on the purchase.
Note 2 – adverting services to DIRCL on behalf of the Maldives operations
Since the service is provided to DIRCL (and invoiced to DIRCL) VAT is chargeable by DIRHL, however,
payment is made to an online website VAT has not been charged from DIRHL. Hence there is no input tax
to DIRHL.
Note 3 - Supply of labour services
The supply of employees The DIRHL provides employees whose salaries are paid through the DIRHL
pay sheet and hired to DIRCL local office and to Maldives branch. The salary is reimbursed through the
local company.
Since the employees are in the pay sheet of DIRHL, the supply of such employees to other companies is a
service for which VAT is chargeable.
The supply of employees to Maldives
a. will be zero rated if the employees work from Sri Lanka ( without physically
present in Maldives and payment is received in foreign currency ; or
b. will be excluded if the workers provide such services in Maldives As the VAT
will be chargeable only if the services are performed in Sri Lanka
c. will be exempt if the services are provided in Sri Lanka to be utilised outside Sri
Lanka for which the payments is received in local currency.

Since the payments were made by DIRCL the supply of services either falls under paragraphs b. or c. above.
no liability to VAT.

38 CA Sri Lanka
Note 4 – calculation of disallowable input tax
Directly disallowable input tax : Rs

Input on Vehicle hiring ( vehicles are used for traveling , hence 75,000
disallowable in full )
[Section 22(6) of the VAT Act]
Input on Catering service for managing director’s personal function 28,500
to the office staff
[Not attributed to a supply liable to VAT ( section 22(3 ) & section
22(6) ]
Input on Motor vehicle expenses – used for travelling 75,000
Disallowable in full 178,500
Proportionally disallowable of input on common expenses
Formula
Input on common expenses / total supplies * exempt supplies
- Total supply other than sale of assets etc , not related to
normal business Rs. 139,590,000 – ( dividends Rs.
4,000,000+ loan interest Rs 13,000,000+ sale of motor
vehicle 10,000,000+ sale of computers Rs. 5,500,000+ sale
of land & building Rs. 15,000,000 = 47,500,000) 92,090,000
- Input on common expenses - telephone Rs. 450,000+ Water
bill Rs. 45,000) = Rs. 495,000
- Exempt supplies – management of Maldives branch Rs.
15,000,000+ employment services to Maldives branch Rs.
5,000,000 )= Rs 20,000,000
- Calculation 495,000/92,090,000* 20,000,000
Exempt supplies/total supplies x input – already
disallowed inputs

(15,000,000 +10,000,000 +5,500,000+5,000,000)x(2,316,000 – 178,500)

144,090,000

35,500,000 x 2,137,500 = 526,623

144,090,000

526,623
Total disallowable input tax 705,123

Note 5 – Calculation of unabsorbed input tax under section 22(10)

- Input allowable cannot exceed the output tax collected
- Such restriction does not apply to zero rated supplies and SVAT supplies
- Calculation
- First remove the input connected to Zero rated and SVAT supplies
Formula – allowable input tax /total liable supplies * zero rates & SVAT supplies
Allowable input tax = Rs. 2,261,827
Total liable supplies = total supplies Rs. 144,090,000 – exempt supplies / excluded supplies (
Rs. 52,500,000 ( 15,000,000 + 4,000,000+ 13,000,000+ 10,000,000+ 5,500,000 -+5,000,000) =
Rs. 91,590,000
- Input attributable to zero rated and suspended supplies

CA Sri Lanka 39
Zero rated supplies +suspended supplies x allowable input
Total supplies – exempt supplies/excluded supplies
( 0 + 30,000,000 +3,000,000+1,500,000) x 2,261,827)
91,590,000

34,500,000 x 2,261,827 = 851,982

91,590,000
Rs. 2,680,946/ 91,590,000*. 34,500,000 (30,000,000+ 3,000,000+ 1,500,000) = Rs. 1,009,855 (
no restriction for this amount)
- Input attributable to other liable supplies = allowable input – input on SVAT supplies
= Rs 2,261,827 - 851,982 Rs 1,409,845
- Output tax collected = Rs. 13,738,500 – SVAT output Rs 5,175,000 = Rs 8,563,500
- Input tax claimed Rs 1,409,845 < output declared of Rs 8,563,500. ( input does not exceeds 100%
of output tax. ) Therefore, no carried forward to next taxable period , the whole amount is claimable
- Alternatively , attribute the input relating to the liable supplies other than zero or suspended
supplies = ( 30,000,000+15,000,000+1090,000+1,000,000+10,000,000)= 57,090,000.
57,090,000/91,590,000* 2,261,827= 1,409,845

Explain the VAT implications on the supply of goods or services to Maldives

- In terms of section 7(c) of the VAT Act the services provided in Sri Lanka to be utilized outside
Sri Lanka for payment in foreign currency is zero rated. However, in this case management services
was provided to Maldives but payment is made by DIRCL locally in local currency. Therefore, in
terms of paragraph (b) of PART II of the First Schedule it is exempt but not zero rated.

- Employment services also provided to Maldives branch, but it has not been specifically stated in
the question whether the employees work in Maldives or provide services in Sri Lanka for the
Maldives branch. In both circumstances there is no liability as if the services provided in Maldives
such services are out of scope as VAT is chargeable only if services are provided in Sri Lanka . If
services are provided in Sri Lanka to be utilized outside Sri Lanka, the payment should be received
in foreign currency but in this case payment is made by the local company. Hence it is not zero
rated but exempt .Further, it should also be noted that employees are not the employees of DIRCL
but such employees are the employees of DIRHL hence it is a service provided by DIRHL to
DIRCL. If DIRCL employees work in Maldives branch it is not a taxable activity but employment.

- Though the advertisement partly for Maldives branch it is directly provided to DIRCL hence liable
to VAT, but in the DIRCL, it is a disallowable input as used for the Maldives branch.

Whether the monthly returns could be submitted instead of quarterly returns since they have to pay
two payment instalments which would miss-match with actual payments;
As defined in section 83 of the VAT Act, monthly Taxable period is entitled on for taxpayer whose
supplies are zero rated supplies or SVAT supplies ( deemed exports, SDP projects or new project under
section 22(7) during the project implementation period , Specified projects or supplies to registered RIPs
) Since DIRHL does not fall under such categories the taxable period is 3 months . There is no option to
register under monthly taxable period.

40 CA Sri Lanka
Whether instalment payments could be paid monthly rather than paying twice a month;
Since DIRHL is a service provider instalment payments should be made twice a month in terms of section
26 of the VAT Act. However, with effect from any taxable period commencing from October 1, 2019 , as
per the amendment introduced to section 26 of the VAT Act by VAT (Amendment) Act No 19 of 2019 ,
the instalment payment is to be made only monthly .
Since the company provides services to overseas branch and to the Indian subsidiary and also to a
SVAT registered RIPs whether the present registration as an RIS could be extended to cover RIP
status as well.
To obtain RIP status more than 50% of the supplies should be exports, deemed exports, supplies to RIPs .
However, out of the total supplies the supplies to RIPs is less than 50%. Services to overseas is not zero
rated in this case as the payment has not received in foreign currency (Total supplies .Rs 144,090,000 .
RIP supplies Rs 5,175,000 is less than 1%) Hence, RIP status cannot be obtained within the provisions of
the Act.

CA Sri Lanka 41
Suggested Answer - Question 2:

DI Ridge Construction Ltd ( DIRCL)

(a) Computation of the VAT liability for the period ending 30. 09.2019
Output Value of Payments Rate VAT Rs
supply received
Performa
Invoice issued
(Rs)
Material exported to India 200,000,000 200,000,000 0% -
( in India there is a separate company to
carry out construction work. Hence it is not
an activity carried out by DIRCL. Only
goods are exported to the Indian company
which is a separate supply. Hence zero rate
is applicable. However, the goods sent to
Maldives branch is not treated as an export
up to 30 September 2019, but it is
considered as excluded supply on which
input is to be disallowed. ( subsequently
this situation has been amended by the
VAT ( Amendment )Act No 19 of 2019 )
Design work done in Sri Lanka for Indian 120,000,000 - Zero rated -
company Rs. 120,000,000/- invoice was Exempt but
raised on September but payment is still there is no
pending. supplies for
( design work is carried out in Sri Lanka to this taxable
be utilized in India for payments in foreign period
currency is zero rated . However, since
payment is not received for this taxable
period it would not be treated as part of the
supply as the company is obtained the cash
basis approval Section 7(c) & section 4 of
the VAT Act)
Local contracts invoiced for the period of 764,000,000 700,000,000 15% 105,000,000
July Rs 300,000,000/- August Rs
254,000,000/- and for September Rs
210,000,000/- Out of which payments
received for the invoices raised in July and
certain invoices raised in April , and May
amounting to Rs 400,000,000/-
( Time of supply is the time of payment as
approval has been obtained for cash basis
under section 23 of the Act. )
New contract was signed with the - 200,000,000 15% 30,000,000
Government Department and the work
started in October 2019, However, in the
month of September mobilization advance
was received Rs 200,000,000/-
(Time of supply under both cash basis &
accrual basis is the time of receiving
payment as the first event - Section 4 of the
VAT Act )
A retainer fee of the contract completed in 10,000,000 15% 1,500,000
January 2019 was received in August Rs.
10,000,000/-
42 CA Sri Lanka
 ( Time of supply is the time of receipt of
payments under cash basis – Section 4 of
the VAT Act)
Excluded supplies/ Exempt supplies :

The construction work carried out in India - 124,000,000 Out of scope -

during the last 6 months period was paid for
which invoices were issued in the last
quarter. The amount is Rs. 124,000,000
( converted in to Sri Lanka Rupees)
( service is provided out of Sri Lanka ,
hence not falling within the VAT scope
though the payment is received in foreign
currency)
Work done in Maldives was invoices for Rs 200,000,000 100,000,000 Out of scope -
200,000,000/- (converted in to SL Rupees)
but out of which only Rs 100,000,000/- was
received.
(Construction work is carried out in
Maldives by a branch of DIRCL, even
though it is a service such service cannot be
provided from Sri Lanka as it is a
construction . Hence , the work done
outside Sri Lanka does not fall within VAT
scope – Section 2 chargeability )
For the new hotel project advance received - 300,000,000 Out of scope
from Maldives Rs. 300,000,000/-
(Advance is received for the work to be
done in Maldives. The work is to be done
outside Sri Lanka. Out of VAT scope –
Section 2 chargeability )
Materials exported to Maldives for the 100,000,000 Not a supply Out of scope -
project done by the company Rs
100,000,000/-
(in Maldives the construction project is
carried out through a branch office in Sri
Lanka and the materials exported for that
project is out of the scope. Hence it is part
of the value of the construction project
carried out by DIRCL and the goods used
does not form part of a separate supply.
However, as per the VAT (amendment) Act
No 19 of 2019 with effect from October 1,
2019 such exports are treated as zero rated
supplies – amendment to section 7 )

Total 1634,000,000 136,500,000

Input
Imports :
Bathroom fittings and equipment were 157,000,000 @ 23,550,000
imported for the local construction project 15%
which is a turnkey project .

CA Sri Lanka 43
 The CIF value is Rs 100,000,000 + Custom
duty Rs 40,000,000/- + PAL Rs.
7.000,000+ 10% of CIF value 10,000,000=
value of import 157,000,000
( Section 6 of the VAT Act , NBT charged
at the point of Customs. Does not form part
of the value of supply for VAT purposes )
Fitting imported for the Managing directors 6,350,000@ 952,500
new house through company account CIF 15%
value Rs 5,000,000 + Customs duty .
500,000 + PAL Rs. 350,000/- + 10% of
CIF value 500,000 = Rs 6,350,000
Section 6 of the VAT Act. NBT is not a part
of the calculation )

Local purchases
Building materials purchased from DIREL 200,000,000@ 30,000,000 -
Rs 200,000,000 but payment made in 15% Not treated as
October 20, 2019 input for this
( in terms of the proviso to subsection (2) taxable period
of section 22 of the VAT Act , in a case as no payment
where the cash basis approval is obtained , was made
the input can be claimed only once the
payment is made)
Payments made for materials purchased 315,000,000 @ 47,250,000 47,250,000
from VAT registered persons Rs. 15% Claimable in
315,000,000 for which invoices received in full
June 2019
(Claimable since payment is made during
this taxable period- section 22(2) proviso,
and assumed that these materials were not
used for the Maldives project , if used such
part should be disallowed as the supply is
out of scope . However, it would be treated
as zero based on the new amendment
introduced in VAT amendment Act No 19 of
2019 )
Management services received from 30,000,000@ Actual payment 30,000,000
DIRHL for the period was Rs. 30,000,000 15% 20,000,000
/- (covered 3 months) but settled only for @15%
two months and the payment for the month
of September 2019 is outstanding. The
amount outstanding is Rs 10,000,000/- .
( input tax is claimable only up to the
amount of payment
DIRHL is responsible in managing the 5,000,000 5,000,0000 Exempt
Maldives branch of DIRCL and the
management functions are carried out by
DIRHL online without visiting the branch
physically. The monthly management fee is
agreed upon at Rs 5,000,000/- three months

44 CA Sri Lanka
 fee was paid to DIRHL on behalf of the
foreign branch.
( since the payment is made in rupees it is
an exempt supply of DIRHL under
paragraph (b) of PART II of the First
schedule – no VAT charged )

Payments for the services provided by 20,000,000 20,000,000 Exempt -

DIREL from Sri Lanka on construction
activity of the Maldives branch Rs
20,000,000.

Interest on loan taken from DIRHL Rs 2,000,000 Not a VAT -

2,000,000. supply

Advertisement services invoiced by 1,090,000 1,090,000@ 163,500

DIRHL Rs. 1,090,000/- total amount was 15%
paid
( Section 22 , expenditure is paid )
Special advertisement for foreign 1,000,000 1,000,000@ 150,000
construction services for the branch office 15%
in Maldives invoiced by DIRHL Rs.
1,000,000. The payment was made to
webpage through internet service
company outside Sri Lanka which is an
online using the space.
( advertisement was billed directly to the
company hence VAT is charged by
DIRHL)
Employment services. DIRHL provides 15,000,000 15,000,000 @ 225,000
employees whose salaries are paid through 15%
the DIRHL pay sheet and hired to DIRCL 5,000,000 5,000,000 Exempt
local office and to Maldives branch. The
salary is reimbursed through the local
company.
Salary reimbursed by DIRCL Rs
15,000,000 out of which Rs 5,000,000 is on
behalf of the branch office.
( Since the service is provided directly by
DIRHL to Maldives and only payment is
reimbursed by DIRCL the service is
exempt and not zero rated )
Telephone bills and internet usage Rs. 1,200,000 1,200,000@ 180,000
1,200,000/- 15%
Water bills Rs 100,000 100,000 100,000@ 15,000
15%
Electricity Rs 450,000 450,000 450,000 Exempt
Total input 102,486,000
Less Disallowable input: Note 1 (16,102,500)
Allowable input 86,383,500
Carried forward unabsorbed input 230,000

CA Sri Lanka 45
 Total input tax 86,613,500
Carried forward input (if any) Note 2 No carried 86,613,500
forward
Balance payable 49,886,500
VAT paid under self-assessment basis (230,000)
* Taxpayer has not paid adequate self-
payments
Payable 49,656,500

Note 1 – Disallowable input tax

Rs
Directly disallowable input
Imported fittings for managing director’s personal use 952,500
Locally purchased materials sent to Maldives projects treated as supplies out of 15,000,000
scope of VAT Rs 100,000,000 @15% paid locally not allowable as the supply is
not liable
Other services provided by DIRHL for Maldives separately billed and VAT is not 150,000
charged as either such services are exempt or excluded except advertisement
charged to DIRCL and input on such advertisement is fully disallowed as the
activities in Maldives is out of scope
Overhead expenses: Telephone and water bill only since there is no local exempt -
supplies and it is very unlikely such expenses could be attributable to Maldives
branch office treated as local overhead expenditure
Total disallowable input 16,102,500

Not 2 – calculation of unabsorbed input tax ( if any)

Formula -- total claimable input tax / total liable supplies * supplies liable to VAT
( since the restriction does not apply to zero rates supplies and SVAT supplies calculation is applied only
for other liable supplies or alternatively input relating to Zero supplies and SVAT supplies could be
deducted from the total input )
Formula 1 = liable supplies ( 200,000,000+ 700,000,000+ 200,000,000+ 10,000,00) 1110
Input 86,613,500/1110,000,000* 910,000,000= 71,007,463 < 136,500,000 , input claimed is less than
the output collected , hence no carried forward the total is claimable
Formula 2 - 86,613,500/1110,000,000 & 200,000,000 ( zero rated supplies ) = 15,606,036
Input relating to liable supplies other than zero rated supplies = 86,613,500 – 15,606,036
= Rs 71,007,463
Either method may be applied

Explain the VAT implications on the supply of goods or services to Maldives and India
The construction activities carried out in Maldives is out of scope of VAT as the services relating to
construction work cannot be provided in Sri Lanka. However, certain management services, design work
etc. may be done in Sri Lanka without going to the other country. In this case, the company cannot bill to
its own branch as it is one entity. if other companies of the group provide such services ( different entities)
if the services are provided in Sri Lanka to be utilized outside Sri Lanka zero rate is applicable . if the local
entity pays in rupees the services are not zero rated but exempted. However, as per the amendment
introduced in the VAT (Amendment) Act No 19 of 2019 export of goods to a foreign construction project
of the same person is zero rates with effect from 1.10.2019.
Export of goods to Indian construction project can be treated as zero rates as it is not part of the local
company but a separate company in India. When services are provided to the Indian company, if such

46 CA Sri Lanka
services are provided in Sri Lanka for payment in foreign currency it is zero rated and if such services are
provided in India it is out of scope of VAT.
Company request your advice on the following:
Presently DIRCL conduct to construction projects in Maldives through a branch established there.
Company request your opinion whether they could start a company in Maldives instead of having a branch
office (PE) and what are the advantages they could get for VAT.
Up to 30.9.2019 when goods are sent to the Maldives Project Company was not eligible to treat such supply
as zero rated supplies. Hence, to be eligible to treat zero rate the only way out was to start a company in
Maldives and not to carry out the construction activities through a branch office. However, as the law has
now been amended to treat the export of goods to the own business to be treated as zero, such a requirement
would not arise.
Explain the legal provisions in the VAT Act, under cash basis accounting for VAT (the time of supply
rule and the issue of Tax invoices) as the company issues Performa invoices based on your advice.)
Cash basis approval could be obtained for construction activity and for consultation activities where there
is a practical issue as there is a gap between the works done and the payment made. For that purposes, the
registered person should make a request to CGIR under section 23 of the VAT Act, and once the approval
is given the time of supply should be at the time of receipt of payment (section 4). In terms of section 20,
a tax invoice can be issued within 28 days (on request made within 14 days by the recipient) from the time
of supply. Accordingly, tax invoice can be issued only once money is collected. Until such time, a Performa
invoice or a commercial invoice can be issued. Further, in terms of section 22(2) of the VAT Act, input can
be claimed only once the payment is made.

CA Sri Lanka 47
Answer - Question 3:

DI Ridge Export Ltd ( DIREL)

(b) Computation of the VAT liability for the period ending 30. 09.2019
Output Value of Rate VAT Rs
supply
(Rs)
Building Materials exported to DIRSL – 150,000,000 0% -
India to be used in the construction projects
carried out
[ DIRSL- India is a separate entity , so
export is Zero rated under section 7(1)]

Supplies of building materials to Strategic 300,000,000 15% 45,000,000*

Development projects during the project
implementation period who are registered
as RIPs.
[ section 2(2)(e) since it is an SVAT supply
credit vouchers are issued)
Building materials supplied to DIRCL 200,000,000 15% 30,000,000
( liable on accrual basis even though
DIRCL has not paid during this taxable
period - at the time of supply under section
4)
Supplies to VAT registered persons 130,000,000 15% 19,500,000

Supplies to customers not registered for 300,000,000 15% 45,000,000

VAT– since VAT is inbuilt in the invoice
value VAT is taken as inclusive
345,000,000/115* 100
( Time of supply is the payment received
though the tax invoice is not issued –
section 4)
Services :
Advice on Structural work and designs to 20,000,000 Exempt -
Maldives projects paid by DIRCL in rupees
( though the services provided in Sri Lanka
and utilized outside Sri Lanka the payment
is made in rupees. Hence the zero rate is not
applied but exempt under paragraph (b) of
PART II of the First Schedule )
Services to SDP projects 25,000,000 15% 3,750,000*
[ Supply to SDP during the project period
is exempt from VAT, However, input tax is
claimable by the supplier notwithstanding
the exemption ( proviso to section 22(6)).
However, as per the SVAT Gazette even the
SDP is not liable VAT registration during
the project implementation period should
be obtained to obtain RIP status to
purchase project related goods or services
)
48 CA Sri Lanka
 Online services relating to construction 300,000,000 0% -
work done by DIRSL – India Rs.
300,000,000 ( converted to rupee value )
(Section 7 (c ) , directly paid from India in
foreign currency is zero rated )
Sale of a construction machinery Rs 10,000,000 15% 1,500,000
10,000,000, this was imported from China,
3 years back and VAT on importation was
claimed
(Certain construction machineries are
exempt from VAT, but this one assumed as
liable as importation VAT is paid and
probably company may have claimed input
tax,)
Supply of locally purchased building 254,000,000 15% 38,100,000*
materials to SVAT registered companies
during the project implementation period
[ section 22(7) projects can get registration
during the project implementation and RIP
status is granted]
Supply of imported materials to SDP 10,000,000 15% 1,500,000*
projects
( SDP is an RIP ,hence supply is
suspended)
Supply of meals to workers 2,000,000 Exempt -
Total 1701,000,000 184,350,000
Expenses :

Imports :
Raw material imported CIF value Rs. 31,900,000 @ 47,875,000
29,000,000, Custom duty, PAL and NBT 15%
exempted and VAT is deferred. Deferred
(Only 10% is to be added to the value as
other taxed as the other taxes are exempted
29,000,000 + 2,900,000 = 31,900,000)
(Input is to be claimed as voucher has to be
collected )
Finished materials imported to be supplied 38,850,000 @ 5,827,500
to RIPs CIF value Rs 30,250,000/- Customs 15%
duty Rs. 6,500,000, PAL Rs. 2,100,000/-
NBT and VAT is charged.
Value = CIF 30,250,000+ duty 6,500,000+
2,100,000 + 10% of CIF 3,025,000 =
38,850,000
[ for finish goods import deferment is not
available even though supplied to RIPs –
section 2(3) ]
Local purchases of goods and services
SVAT purchases

CA Sri Lanka 49
 The management fee paid to DIRHL was 30,000,000 Not claimable
Rs. 10,000,000 per month and since DIREL @15% as paid
is registered for month basis, the invoice for SVAT through
the period covering the months (June, July 4,500,000 voucher
& September was issued on 30th September
2019.)
( SVAT vouchers not claimable )
Building rent paid to DIRHL for a month is 3,000,000 Not claimable
Rs 1,000,000/- for 3 months Rs 3,000,000 @15% as paid
SVAT through
450,000 voucher
Advertisement services - paid to DIRHL 1,500,000 Not claimable
Rs 1,500,000 @15% as paid
225,000 through
voucher
Purchase of building materials locally Rs. 30,000,000@ Not claimable
30,000,000 15% as paid
4,500,000 through
voucher
Telephone bills Rs 130,000/- 130,000/- @ Not claimable
15% as paid
19,500 through
voucher
Company provide meals to workers and the 2,000,000@ Not claimable
supply was outsourced. payments to meal 15% as paid
suppliers Rs 2,000,000 through
( under the proviso to section 22(6) of the voucher
VAT Act , input is claimable even though
the supply of meal is exempt . So SVAT
facility can be obtained for this)
(input on SVAT purchases cannot be claimed as no payment
made. However, if any disallowable part is there such amount
should be disallowed – SVAT Gazette reference )
Purchases from persons registered for
VAT but not registered for SVAT
Equipment for the factory 12,000,000@1 1,800,000
5%
Water filters 2,000,000@ 300,000
15%
Car hiring fee 100,000@ 15,000
15%
Stationery 3,000,000@ 450,000
15%
Furniture for the office 12,000,000@ 1,800,000
15%
Security services Rs. 2 ,000,000 2,000,000@ 300,000
15%
Purchases form persons not registered
for VAT

Janitorial services 200,000 No VAT

General office purchase 1,000,000 No VAT
50 CA Sri Lanka
 Fertilizer for the garden plants - fertilizer is 200,000 No VAT
anyway exempted
Loan interest on temporary loan facilities 1,000,000 Not a VAT
granted by DIRHL liable supply
Total input 58,367,500
Disallowable input – Note 1 (15,000)
58,325,500
Carried forward unabsorbed input credit 200,000
from last month
Input allowable 58,525,500
Calculation of unabsorbed input Note 2 No carried - (58,525,500)
forward
Payable 125,824,500
SVAT credit ( 45,000,000+ (88,350,000)
3,750,000+38,100,000 +1,500,000)
Company has not paid self-assessment payment considering the unabsorbed
VAT
37,474,500
Payable to the IRD to obtain the voucher for the amount payable to the Customs (85,350,000)
Deferment facility - credit voucher (47,875,000)

Note 1 – Disallowable input tax

Rs
Input on car hire [ section 22(6)] 15,000
Company does not have any exempt supplies except structural work done
in Sri Lanka to be utilized in Maldives , however where is no material
input commented to that , hence overhead expenses were not apportioned
( only one transaction)
Meal provided to employees is exempt from VAT under paragraph (b) of
PART II of the First Schedule, however, input is allowable , hence would
not be a part of the disallowable input
15,000

Note 2 – calculation of unabsorbed input ( if any)

Formula
Input allowable/ total liable supplies * liable supplies other than Zero rated supplies and SVAT supplies
to RIPs
Or Total input – (Input allowable / total liable supplies * Zero rates and RIP supplies)
And compare with VAT output tax other than payments through vouchers
Total liable supplies = Rs 1701,000,000 – (Rs 20,000,000 services provided in Maldives + Rs
2,000,000) – Rs . 1679,000,000
Supplies other than zero and SVAT supplies Supply of building material locally Rs 630,000,000
(300,000,000+200,000,000 +130,000,000) + sale of equipment Rs 10,000,000 = Rs 640,000,000
Input attributed Rs 58,525,500/ 1679,000,000* 640,000,000 = Rs 22,308,707
Output collected – Rs 96,000,000 (30,000,000+45,000,000+19,500,000+ 1,500,000)

CA Sri Lanka 51
 Input claimed Rs 22,308,707 < output collected Rs. 96,000,000. Hence No carried forward the whole
input is claimable
[Section 22(10) – input tax is restricted to 100% of output tax. This restriction is not applicable to zero
rated supplies and supplies to RIPs]

Explain the VAT implications on the supply of goods or services to Maldives and India
- The supply of services to Maldives if such services are provided in Sri Lanka to be utilized
in Maldives will be zero rated if the payment is received in foreign currency. However, in
this case, payments are made locally in rupees. Hence, not zero rated but exempt under
the exempt Schedule.
- If the services are provided in Maldives, not coming within the VAT scope as VAT is
chargeable only if such services are provided in Sri Lanka.
- The same rules are applicable with regards to services provided to Indian company.

Company request your advice on the following:

- Whether the company could obtained deferment facility on the importation of building materials
supplied to SVAT registered RIPs without further production process: Deferment facility is
granted under section 2(3) of the VAT Act only for raw materials or machinery for manufacture
of goods for export. When finished goods are imported to supply to exporters or deemed exporters
no provisions to give deferment facility. So if such goods are supplied to RIPs the VAT paid to
Customs by the supplier will be a refund subject to other adjustments.

- VAT implication on the related party transactions – Arm’s length principle should be maintained
as provided in section 5 of the VAT Act.

52 CA Sri Lanka
 Taxation of non-residents and International Taxation

Question 1

(a) Explain, based on the meaning of “Assessable Income” of a person (Resident or

Non-resident) for a Y/A from any income source as stipulated in Inland Revenue
Act No. 24 0f 2017, how the Double Taxation of a same income (i.e. taxation of
same income in two jurisdictions) could arise.

(b) The main objective of entering into bi-lateral Agreements between respective two
Countries (or jurisdictions) for the avoidance of double taxation, has been the elimination
of adverse effect arising from the same income being taxed in two jurisdictions.
Explain briefly the other objectives of Countries for entering into Double Tax Avoidance
Agreements.

(c) Elucidate the concept of ‘Permanent Establishment [PE]’ as defined in the “Double
Taxation Avoidance Agreements” for the purposes of determining the business profits of
a non-resident person.

Question 2

Mr. Naresh, a Malaysian citizen, is an expert in information technology employed by a

company in Malaysia. He arrived in Sri Lanka on the 1st May 2018 In connection with a project
undertaken by the company. Having completed the work in Sri Lanka, he left for Taiwan on
the 30st September 2018.

Details of his income during this Y/A 2018/19 are as follows:

(i) Remuneration from Malaysia Company for the full Y/A (at an amount equal to
Rs.1,000,000/- per month) in aggregate Rs. 12,000,000/- has been remitted to Naresh’s
current A/C in Malaysia, and the income tax paid thereon is equal to Rs.1,500,000/-.
(a DTA is in force between Sri Lanka and Malaysia)

(ii) Interest income (net after 10% tax) accrued over the Y/A on deposits in the savings
account in Taiwan bank is equal to Rs.1,000,000/- (a DTA is not in force between
Taiwan and Sri Lanka or Malaysia)

(iii) Allowances paid to Naresh by the project company in Sri Lanka during his service
period in Sri Lanka is Rs.5,000,000/- (This is in addition to his remuneration in
Malaysia)

Based on the above information, ascertain the income of Mr. Naresh liable to tax in Sri Lanka
for the year of assessment 2018/19.

CA Sri Lanka 53
Question 3
Minex (India) Ltd, a Company incorporated in India, has set up a branch in Sri Lanka for the
manufacture of rubber-based products. In computing the income of this Branch in Sri Lanka for
the Y/A 2018/19 (having considered the DTA between Sri Lanka and India) the company has made
the under-mentioned deductions as well.
(i) Rs. 1,000,000/-, paid to the head office of the company in India as reimbursement of
interest paid on the bank loan obtained by Head Office for purchasing a plant which is
used by the Sri Lanka Branch.

(ii) Rs.2,000,000/-, research and development expenses incurred by the Head Office for the
improvement of the product manufactured by the Branch.

(iii) Rs.2,500,000/-, fees paid to the branch (of the Company) in Singapore for providing
special management services to Sri Lanka Branch

(iv) Rs.3,000,000/-, Payment made to the head office as Royalty for the use of a software
provided by the Head office.

Determine the correctness of deductions under each of above items, given that the manner of
determining business profits under the DTA between Sri Lanka and India is in line with the
United Nations (UN) modal.

53 CA Sri Lanka
ANSWERS

Question 1

(a) The imposition of income tax (or any other tax) by any country or jurisdiction is (generally)
through their legislative process. In that, the respective country chooses on the appropriate
basis of taxation to be adopted. In the world, most of the countries (except a few) impose
income taxes, and such imposition by most of them are based on the combination of
residence principle and source principle (except a few Countries such as USA that follows
the combination of citizen, resident and source principles while a few other countries such
as Hong Kong adopt the source principle only). Under the source principle of taxation, a
country tax all income from sources within its territorial jurisdiction. Under the residence
principle of taxation, a country taxes worldwide income of persons residing within its
territorial jurisdiction. The nationality principle for taxation of income envisages taxation of
income of nationals of a state irrespective of whether it arises in that state or any other state.

As such, a person of a country (home country) who earns from another country (source
country) could be liable to income tax in that source country under the source principle, and
also on the same income for the same period in his home country under the residence
principle. Accordingly, a double taxation of same income in two jurisdictions could occur.
This is known as Juridical (or international) double taxation, that is a form of double
taxation that occurs when a person is taxed on the same income both by its country of
residence and the country of source.

In Sri Lanka, as stipulated under Section 4 of Inland Revenue Act No. 24 of 2017, the
assessable income of a person for the year of assessment from employment, business,
investment or any other source shall be:

- in the case of a person resident in Sri Lanka, the income from every source wherever
the source arises, and

- in the case of a person not resident in Sri Lanka, the income to the extent that arises
from a source in Sri Lanka.

This is a taxation basis that combines the source and resident principles. Accordingly, all
residents of Sri Lanka will be liable to income tax in respect of all sources of income,
whether within the jurisdictions of Sri Lanka or elsewhere. Any non-resident of Sri Lanka
will be liable to income tax only in respect of sources within Sri Lanka.

(b) The preamble of most Agreements for the Avoidance of Double Taxation recites that the
purposes (main objectives) thereof are “the avoidance of double taxation and the
prevention of fiscal evasion with respect to taxes on income and capital”. Apart from the
avoidance of double taxation, the prevention of fiscal evasion with respect to taxes is the
55
 second most objective of such tax agreements. This is achieved through the Exchange of
Information with parties to the agreement which is aimed to combat evasion.

The other objectives of entering into double tax avoidance agreements are –

o Promotion of international trade,

o Encouragement of the flow of investment, technology and technical know-how (into
developing countries, particularly),
o Creation of certainty and tax stability,

o Provision of a mechanism for resolution of international tax disputes, and

o Prevention of tax discrimination.

(c) Every agreement for the Avoidance of Double Taxation (DTA) includes the concept of
“Permanent Establishment (PE)”, formulated based either on the UN modal or OECD
modal, or any other for the purpose of providing a relieved basis for taxation of business
profits of non-resident persons. Actually, the concept of PE is a defined business connection
of a resident person of a country having within another country (source country). DTAs
generally define and include any of the following types of PEs depending on the purpose:

• Asset type PE (Fixed rule PE), which means a fixed place of business through which
the business of an enterprise is wholly or partly carried on,
• Construction PE, in relation to construction or assembly projects etc.,
• Service PE, as regard the provision of services through employees or other personnel,
• Agency PE, which is a depending agent in the source country,
• Insurance PE, as regard the insurance business carried out through a depending
Agent

If a DTA is in force between two countries, when a person resident in one country carries on
business in another country without creating a PE therein, such person will not be liable to
income tax in that source country.

56
Question 2
Mr. Naresh
Y/A 2018/19
Naresh arrived in Sri Lanka on 01.05.2018 and departed for Taiwan on 30.09.2018. Accordingly,
the duration of his stay in Sri Lanka (serving as an employee) is only around 5 months during the
year 2018, before he departed for Taiwan.

According to the facts given and the respective provisions of Inland Revenue Act No. 24 of
2017, Naresh has been a non-resident in Sri Lanka for the Y/A 2018/19. As such, his
remuneration from Malaysia and interest income from Taiwan will not be liable to income tax in
Sri Lanka. As he has rendered services (as an employment) for 5 months in Sri Lanka, the
remuneration for that period will be liable to tax in Sri Lanka, wherever the payment for such
service is made [Sec 73(1)].

The relief provided under Article 15 of the DTA between Sri Lanka and Malaysia will not be
applicable to Naresh, though his presence in Sri Lanka was less than 183 days, but for the reason
that a part of the remuneration was borne by the project company in Sri Lanka.

Remuneration from Malaysia for the full Y/A 12,000,000

Portion applicable for Malaysia service 7,000,000
Applicable portion for Sri Lanka period [i.e. 5 months]. 5,000,000
Allowances paid from Sri Lanka Co. 5,000,000
Income liable to tax in Sri Lanka for the Y/A 2018/19 10,000,000

However, as Mr. Naresh continued to be resident in Malaysia, he will be liable to income tax in
Malaysia on his world income. Nevertheless, under the Article 23 of the TDA DTA between the
two countries, Mr. Naresh will be entitled to receive an appropriate tax credit on the income tax
paid in Sri Lanka.

Question 3

Minex Ltd
Y/A - 2018/19
The Branch of Minex (India) in Sri Lanka is, under the provision of DTA, a Permanent
Establishment (PE) of that non-resident company (Minex). Therefore, the profits of the PE
should be computed taking into account of any relief provided in the DTA between the two
countries. For tax purposes, the profits of a PE is taxed always as a non-resident person.
As stipulated under Article 7 of the DTA between Sri Lanka and India, only the profits
attributable to the PE is liable to income tax in Sri Lanka. The paragraph 3 of Article 7 thereof
(as quoted bellow) provides for the manner and basis of ascertainment of profits of the PE

Accordingly

(i) Interest paid as a reimbursement (Rs. 1,000,000/-), being actual expenses paid to the
bank (a third party) is allowable, though generally any interest paid to the Head
Office is not allowed. There is no adjustment due regarding this amount.

57
 (ii) Rs. 2,000,000/-, being R&D expenses incurred by Head Office. No restriction on the
deduction of such research and development expenses (even incurred by the Head
office), as such amount is in relation to the Sri Lanka Branch. The amount is
allowable and no adjustment due.
(iii) Special management fees paid to the Singapore branch amounting to Rs. 2,500,000/-
is not allowable, under the specific restriction (UN policy) on the deduction of
management fees payable to the Head Office or any of its Offices (related party).
This amount should be added back.
(iv) Royalty paid to the Head Office being Rs.3,000,000/- is not allowed (UN policy).
This is as reflected from the paragraph 3 of Article 7 (quoted bellow from the DTA
with India), where any royalty payable to the Head Office or its related Offices falls
within non-deductible items.

Paragraph 3 of Article 7 of DTA between Sri Lanka and India

“3. In determining the profits of a permanent establishment, there shall be allowed as deductions
expenses which are incurred for the purposes of the permanent establishment, including executive and
general administrative expenses so incurred, whether in the State in which the permanent
establishment is situated or elsewhere, in accordance with the provisions of and subject to the
limitations of the tax laws of that State. However, no such deduction shall be allowed in respect of
amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the permanent
establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or
other similar payments in return for the use of patents, know-how or other rights, or by way of
commission or other charges for specific services performed or for management, or, except in the
case of banking enterprises, by way of interest on moneys lent to the permanent establishment.
likewise, no account shall be taken, in the determination of the profits of a permanent establishment,
for amounts charged (otherwise than toward reimbursement of actual expenses), by the permanent
establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or
other similar payments in return for the use of patents, know-how or other rights, or by way of
commission or other charges for specific services performed or for management, or, except in the case
of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise or any
of its other offices”.

58
 Case Study
Question 01

(a) The business of Plantation Management Ltd consisted almost of the managing the
estates belonging to Emerald Estates Ltd under successive agreements entered in to
between the two companies. Plantation Management Ltd derived over 98% of its income
from this management. The latest agreement between two companies was to last until the
end of 2025, but Emerald Estates had to go into liquidation in 2019. Consequently,
Emerald had to pay a sum of Rs.15,000,000/- to the management Company, in accordance
with the agreement. However, with the termination of agreement, practically nothing
remained of the business of Plantation Management Ltd. The company was compelled
to reduce the staff and had to even shift their office to a tiny place in a small building.

The sum received was declared by Management company in the tax return as a capital
receipt not liable to tax.

However, the Assistant Commissioner of Inland Revenue took the position that the
payment is liable to tax as a normal business receipt, as it was an agreement incidental to
the normal course of the business of the Management Company.

If you are consulted, what is your advice to Plantation Management Ltd?

(b) Carson (Lanka) Ltd made a practice of entering into agency agreements for the sale of
products of various manufacturers on a commission basis. At the beginning of 2019, the
Company had 18 such agency agreements in operation. In May 2019, a lucrative agency
agreement valid up to the 2025 to represent a leading margarine manufacturer was
terminated at the request of the manufacturer. Having considered the cancellation of the
agreement, the manufacturer paid a compensation of Rs.5,000,000/- to Carson (Lanka).
The Assistant Commissioner of Inland Revenue took the position that the compensation
payment of Rs. 5,000,000/- should be liable to tax as a normal business receipt as it was
an agreement incidental to the normal course of its business. However, the Company
argued that the whole structure of their business was affected by the cancellation of this
agreement and the payment made by the manufacturer was therefore was a capital receipt
not liable to income tax.
If you are consulted, how do you advise the Company?

CA Sri Lanka 59
Question 02

(a) Determine the deductibility of each of the following sums (for tax purposes) by the
respective person. You are expected to explain in brief as to whether each sum in question
is deductible under current Inland Revenue Act, in the light of any relevant case
precedence (Case Law).

(i) Rs. 1,400,000/-, being the cost incurred by a Company for employing professional
assistance in connection with making a tax appeal to the Court of Appeal. (The
decision of the Court was in favor of the Company).

(ii) Penalty of Rs. 50,000/- paid by a taxpayer, under a Court Order, in connection
with an action filed against him for selling a product in violation of Government
Regulations on Maximum Retail Price.

(b) Arun is a dedicated employee of a Mercantile Firm. While on a personal tour, he met with
an accident sustaining critical injuries. Consequently, he had to be hospitalized and
treated for a few months. He had to be undergone a surgery as well. The cost of medical
expenses including hospital charges amounted to Rs. 3,100,000/- but the Firm took a
decision (on a humanitarian grounds) to bear the entire bill of such medical charges in
consideration of Arun’s personal qualities even though the company was not bound to do
so under the service contract with employees.

Can the medical expenses of Arun as borne by the Firm be treated to be a part of his
employment income liable to income tax? Answer with reference to relevant case
precedence.

60 CA Sri Lanka
ANSWERS

Question 1
(a) The business of Plantation Management Ltd consisted almost, of managing states
belonging to Emerald Estates Ltd, under successive agreements. The income derived by
the Management Company from other managements was less than 2% of its total income.
Apparently, due to unforeseen reasons Emerald Estates Ltd had to go into liquidation
little more than 5 years ahead of the expiry of the latest agreement. Consequently,
Emerald Ltd had to pay Rs 15,000,000/- to the management company under the terms of
the agreement.

This sum of compensation could not be treated simply as normal business profits, and the
arguments of ACIR are not tenable according to the relevant facts. In this case virtually
the whole asset of the appellant Company consisted in this agreement. When the
agreement was surrendered nothing remained of the company’s business and obviously,
Management may have faced many difficulties as the cancellation of the agreement
affects the whole structure of its business.

In the case of Barr Crombie and Company vs CIR, where the facts and circumstances
are somewhat identical to those of this case, a similar compensation paid had been
determined by Courts as a capital receipt.
Therefore, Management Ltd is advised that the amount received can be treated as a capital
receipt not liable to income tax.

(b) Carson (Lanka) Ltd received a compensation in view of the cancellation of the agency
contract before the date of expiry of the Agreement. According to the facts, this is one
amongst around 18 of such other contracts. As such, this agreement was also a contract
incidental to the normal course of the business of the company. Therefore, this contract
cannot be treated as an enduring asset of the business. Further, the cancellation of one
agreement out of around 18 cannot be argued to affect the whole structure of the company.

In the case of Kelsall Parsons vs CIR, where the facts and circumstances are somewhat
similar to those of this case, the compensation paid had been determined by Courts as an
ordinary business receipt.

CA Sri Lanka 61
 As such, the compensation received by Carson (Lanka) on the termination of the agency
contract cannot be incidental to capital, but to revenue. Therefore, the company is advised
that the sum received as compensation is liable to income tax.

Question 2

(a) (i) The Cost of employing professional assistance in connection with an appeal made
to the Court of Appeal is not an admissible deduction, irrespective of whether the
decision is in favor or not. Simply because such expenses are not incurred in the
production of income.

In the case of Allen Vs Farquharson, this position had been confirmed. In that
case, Finlay J. said
“--------it is impossible to say that this was an expenditure for the purpose
of earning the profits --------I cannot see that the profits were the slightest
bit altered, either decreased or diminished, as a result of this expenditure”

(ii) A penalty of Rs. 50,000/- was paid by the trader under a Court Order due to the
violation of law. As the business could have been carried out without violating the
law, this sum cannot be treated as incurred in the production of income. Section
10(b)(iii) of IR Act No.24 of 2017 specifically disallowed the deduction of such an
expense.

Further, the decision of the Courts in the case of CIR vs Alexander Von Glehn &
Co Ltd was that, a penalty paid by a company for infringement of provisions of
Customs (War Powers) Act was an expense incurred quite outside the earning of
profits in the company’s trade.

62 CA Sri Lanka
(c) The profit from employment is ‘any payment made for the service rendered’ in the
course of an employment. Further, whether a payment is an employment income (or
not) should be decided based on the recipient’s point of view.

In this case, the total cost on medical treatments and hospital facilities provided to Arun
was borne by the Firm on humanitarian ground. As such, this benefit cannot be
attributable to the service that Arun provides to the Firm. In other words, benefit
provided by the Firm can be seen entirely on personal grounds and not consideration of
the service (present, past or future). Therefore, such benefit cannot be treated as part of
the employment income of Arun.

In the Case of Craib vs CIT, a case decided by SL Court, monetary assistance given by
the employer in consideration of sickness of an employee was decided to be not for the
service rendered and not liable to income tax as employment income.

As such, medical expenses of Arun borne by the Firm can be treated as not forming part
of his employment income.

CA Sri Lanka 63