1.2 Direct taxes and Indirect taxes

Question 1

Types of direct taxes:

Answer 1

• Tax on trading income
• Capital taxes
• Property taxes
• Wealth taxes

Question 2

Tax on trading income

Answer 2

• Trading income is the income from main business activity
• The tax base used to calculate this tax is taxable trading profits
• To calculate taxable trading profits the accounting profit needs to be adjusted
• The taxable trading profit will then be charged at the appropriate tax rate for the accounting period

Question 3

The standard pro forma for calculating taxable trading profit

Answer 3

Accounting profit
LESS: Income exempt from tax or taxed under other rules
ADD: Disallowable expenses
ADD: Accounting depreciation
LESS: Tax depreciation allowance
= Taxable trading profit

Question 4

Capital taxes

Answer 4

Capital tax gains are gains made on the disposal of investments and other non-current assets (eg: listed stocks, shares and property)
- calculated as proceeds from sale of asset less cost of the asset
- the chargeable gain will be charged at appropriate tax rate for accounting period

Question 5

Indexation

Answer 5

In a few countries an allowance is made for inflation
- Indexation will typically be calculated on all allowable costs from date of purchase to date of disposal
- this indexation allowance will reduce the gain

Question 6

The standard pro forma for calculating chargeable gain

Answer 6

Proceeds
LESS: Costs to sell the asset
= Net proceeds
LESS: Cost of original asset
LESS: Costs to purchase the asset
LESS: Enhancement costs
LESS: Indexation allowance
= Chargeable gain

Question 7

Property taxes

Answer 7

Many countries impose tax on property (land and buildings) based on either the capital value or the annual rental value
(USA also taxes cars, livestock and boats)

Question 8

Wealth taxes

Answer 8

Some countries also impose a wealth tax on an individuals / entity’s total wealth
- can include pension funds, insurance policies and works of art

Question 9

Two types of indirect taxes

Answer 9

• Unit taxes - based on the number or weight of items (eg: excise duties)
• Ad valorem taxes - based on the value of items (sales tax)

Question 10

Examples of indirect taxes

Answer 10

• Excise duties
• Consumption taxes
• Cascade tax
• Value added tax (VAT)

Question 11

Excise duties

Answer 11

These are a type of unit tax applied on certain products such as alcohol, tobacco, mineral oils and motor vehicles (based on weight or size of the tax base)

Question 12

Excise duties are imposed to

Answer 12

• discourage over-consumption of harmful products
• pay for extra costs (increased healthcare or road infrastructure)
• tax luxuries (USA - fishing equipment, firearms and air tickets)

Question 13

The characteristics of commodities that make them suitable for excise duties are

Answer 13

• few large producers
• inelastic demand with no close substitutes
• large sales volume
• easy to define products covered by the duty

Question 14

Consumption taxes

Answer 14

These are taxes imposed on the consumption of goods and added to the purchase price

Question 15

The two types (stages) of consumption tax are

Answer 15

• Single stage tax - apply to only one level of production (either manufacturing, wholesale or retail level) (USA uses retail sales tax)
• Multi stage tax - is a tax charged each time a component or product is sold

Question 16

Two types of multi stage tax:

Answer 16

• Cascade tax
• VAT

Question 17

Cascade tax

Answer 17

This is where tax is taken at each stage of production and is a business cost because no refunds are provided by local government

Question 18

Value added tax (VAT)

Answer 18

VAT is charged each time a component or product is sold but the government allows businesses to claim back the tax they have paid (input tax)
The entire tax burden is passed to the final consumer
VAT system used by most countries

Question 19

VAT payable =

Answer 19

Output tax - Input tax

Output tax = VAT charged on sales to customers
Input tax = VAT paid on purchases

Question 20

Taxable supplies for VAT could be

Answer 20

• Standard rated - taxed at the standard rate of vat
• Higher rated - taxed at a higher rate of vat
• Zero rated - taxed at a rate of 0% (basic food, eg bread) (business allowed to claim back input VAT)
• Reduced rate - taxed at a lower rate than standard rate
• Exempt - not subject to tax (businesses can’t claim back input vat)

Question 21

VAT calculations

Answer 21

Taxable supplies have a selling price exclusive of VAT (net price) and a selling price inclusive of vat (gross price)

If the exclusive price is given, vat is calculated by:
= Exclusive price x tax rate

If the inclusive price is given, vat is calculated by:
= Inclusive price / (100 + tax rate) X tax rate