KE3 - FUNDAMENTALS OF TAXATION AND LAW
Suggested Answers and Marking Guide (English)
Suggested Answers and Marking Grid
PART A
TAXATION
SECTION 1
Answer 01
1(a)
1.1.
Learning Outcome:
1.1.1 State the economic and social functions of taxation
Correct answer: A
Equity, progressivity, simplicity, stability
1.2.
Learning Outcome:
3.1.2 Explain specific adjustments applicable to the computation of Statutory
income of a company, from rent, interest, dividend and profit from trade
or business (other than adjustments applicable to intercompany
transactions).
Correct answer: D
(iii) only
1.3.
Learning Outcome:
2.2.3Calculate the statutory income from other sources of income(including
rent, net annual value, interest, dividends, royalties, annuities, winning from
lottery, betting or gambling and income from any other source)
Correct answer: C
Rs. 1,800,000 being net sale proceeds of his residential house in Kandy
1.4.
Learning Outcome:
5.2.3 Computation of NBT in a straight forward, non-complex scenario
Correct answer: B
Rs. 1,500,000
2
1.5.
Marking Scheme
Learning
Outcome:
3.1.5 Explain the tax liability of a company on deemed distributions.
Correct answer: C
Rs. 480,000
1.6.
Learning Outcome:
1.2.1 State the role of tax authorities in Sri Lanka.
1.
2.
3.
4.
Department of Inland Revenue
Provincial Departments of Revenue
Department of Customs
Department of Excise
1.7.
Learning Outcome:
2.2.1 Calculate the statutory income from a small or medium scale trade,
business, profession or vocation, taking in to consideration allowable
and disallowable expenses, capital allowances and disposal of capital
assets.
Profit/(Loss) on disposal = Rs. 120,000
Working (Rs.)
Profit
Selling price
WDV
Profit
= (Selling price – Tax W.D.V.)
= 520,000
=2,000,000-(2,000,000 x 20% x 4yrs)
= 400,000
= 520,000-400,000 = 120,000
= 120,000
1.8.
Learning Outcome:
2.2.3Calculate the statutory income from other sources of income(including
rent, net annual value, interest, dividends, royalties, annuities, winning from
lottery, betting or gambling and income from any other source)
1. Statutory rent income = Rs.150,000
3
Working (Rs.)
Gross rent
Less: Rates
Balance
Allow. For rep. 25%
Net rent
NAV
=15,000 x 12
=200,000 x 10%
180,000
(20,000)
160,000
(40,000)
120,000
200,000 x (1-25%)
150,000
2. House occupied solely for residential purposes / Floor area does not exceed
500 square feet
1.9.
Learning Outcome:
5.1.2 Computation of VAT payable in a straightforward, non-complex scenario.
VAT Payable for the quarter: Rs. 292,500
Output tax (4,500,000 x 12%)
Claimable input tax = (360,000-30,000) x 4.5/6
Balance payable (540,000 -247,500)
= 540,000
= 247,500
= 292,500
1.10.
Learning Outcome:
3.1.4 Compute the gross income tax liability and balance tax liability of a small
or medium sized company.
Creative Toys PLC – (40,000,000 x 28%) = 11,200,000
Toy Land (Pvt) Ltd – (4,200,000 x 28%) = 1,176,000
Marking Guide
Each question carries 2 marks.
Total 20 marks.
4
SECTION 2
Answer 02
1.
Learning Outcome:
2.2.1 Calculate “statutory income” from a small or medium-scale “trade,
business, profession or vocation”, taking into consideration “allowable
and disallowable expenses, capital allowances” and disposal of capital
assets.
2.2.2 Calculate employment income (including all cash and non-cash benefits,
excluding terminal benefits).
2.2.3 Calculate statutory income from other sources of income (including rent,
net annual value, interest, dividends, royalties, annuities, winnings from
lottery, betting or gambling and income from any other source).
2.2.4 Identify the “miscellaneous exemptions” under the Inland Revenue Act
(Sec. 13) applicable to an individual and capital gains.
2.3.1. Compute the total statutory income, assessable income and taxable
income taking into consideration relevant statutory deductions and
aggregation of child’s income.
2.4.1 Identify rates of income tax applicable to an individual, (including
“ceiling of tax rates” introduced from time to time).
2.4.2 Compute gross income tax liability for an individual.
2.4.3 Compute the balance tax payable, taking into consideration the various
types of tax credits.
5
Mr. Uthpala Perera
Computation of Taxable Income
Year of Assessment 2013/14
Rs.
Employment income
Net Salary
Add: EPF Deduction
180,000/12 x 8
PAYE Deduction
Gross Salary
Festival Allowance
Medical bills reimbursed
Housing Benefit
(a) Rental Value (200,000 + 20%)
(b) Rent paid to owner (25,000 x 12)
1,305,000
120,000
75,000
1,500,000
Rs.
Rs.
1,500,000
50,000
60,000
Marks
1
1/2
1/2
240,000
300,000
Whichever is higher
Gross remuneration does not exceed 1.8 million
Therefore value of benefit limited Rs. 120,000
Profession – Consultancy Service
Adjustment of Net Profit for Tax Purposes
Net Profit
Salaries paid to spouse is an allowable expenditure,
Added to Statutory Income of Mr. Perera
Advertising Expenses
Staff Vacancy Notice
12,000 Fully allowed
Commercial Advertising
48,000 x 25% D/A
Purchase of Computer – Capital Expenditure D/A
Entertainment Expenses D/A
Accounting Depreciation
Electricity & Telephone – 80,000 x 80% Personal
Depreciation Allowance
Furniture (2011/2012) 60,000 x 20%
Computer (2013/2014) 80,000 x 25%
300,000
120,000
+
600,000
-
-
-
1,730,000
1
1/2
1/2
1/2
1/2
1/2
1/2
12,000
80,000
20,000
32,000
64,000
12,000
20,000
32,000
1/2
1/2
Adjusted profit
808,000
(32,000)
776,000
Interest on Fixed Deposit (Final Tax Deducted)
276,000
Not
Taxable
-
1/2
Profit on Sale of Shares
300,000
Exempted
-
1/2
Salaries paid to Spouse
Aggregation of Child’s Income
Interest Income (Gross)
150,000
1/2
45,000
1/2
Total Statutory Income
Less: Deductions under Section 32
Housing Loan Interest Paid
Credit Card Interest – Not Allowed
2,696,000
776,000
123,000
-
6
1/2
1/2
Total Deduction
Note: Deduction limited to non-employment income of
(2,696,000 – 1,730,000) Rs. 966,000.
Assessable Income
Less: Tax Free Allowance
Less: Allowance for Qualifying Payments
a) Donation to Govt. School
b) Donation to Approved Charity
123,000
(123,000)
1/2
2,573,000
(500,000)
Limit
100,000
80,000
c) Premia on Insurance Policy for Incurable
Diseases
d) Qualifying Payment on Employment Income
Note: Deduction for Q/Payments other than (d) is limited
to balance Non-employment income of (966,000 – 123,000)
Rs. 843,000
Taxable Income
Computation of Tax Liability
On 1st
On next
On profit from professional service (Balance)
Gross Income Tax
Less: Tax Credits
PAYE Deductions
Self-Assessment Tax Paid
Balance Tax Payable
N/A
Lower of
1/3 of A.I.
or 75,000
N/A
N/A
Allowanc
e
100,000
75,000
1/2
1/2
48,000
1/2
100,000
(323,000)
1/2
1/2
1,750,000
500,000
500,000
750,000
1,750,000
@ 4%
@8%
@10%
75,000
40,000
7
1/2
20,000
40,000
75,000
135,000
1/4
1/4
1/2
(115,000)
20,000
1/2
2.
Even though he has paid total income tax due for the period he has legal obligation to submit
a return of income for the year of assessment 2012/2013, to the department of Inland
Revenue. The return of income should be submitted on or before 30th November 2013.
Therefore what he has done in not correct. (He is not correct.)
Marking grid
2 marks for explaining
3.
i) It should be submitted in writing, addressing to the CGIR, clearly explaining the
grounds for appeal.
ii) Appeal must be made within 30 days since the receipts of the assessment
iii) The proof of income tax payments made should also be attached to the appeal
Marking grid
3 marks for explaining
8
PART B
LEGAL FUNDAMENTALS
SECTION 1
Answer 01
1(a)
1.10.
Learning Outcome:
1.3.1 Identify the Courts in Sri Lanka and their functions
Correct answer: D
To the Mediation Board.
1.11.
Learning Outcome:
2.1.1 Explain offer & acceptance
Correct answer: B
Mahela’s reply to Kumar is the counter offer to Kumar’s initial offer.
1.12.
Learning Outcome:
5.7.5 State the relationship between partners
Correct answer: D
Every partner is not entitled to take part in the management of the partnership
business.
1.13.
Learning Outcome:
8.2.1. State briefly on each of these Acts: Prevention of Money Laundering
Act No. 05 of 2006, Electronic Transactions Act No. 19 of 2006,
Computer Crimes Act, Consumer Protection Act, Intellectual Property
Act No. 36 of 2003.
Correct answer: D
Authorized disclosure of information, which enables another to access any service
provided by a computer.
9
1.14.
Marking Scheme
Learning
Outcome:
9.1.1 Explain the process of international sale of goods
Correct answer: A
Documentary Credits.
1(b)
1.15.
Learning Outcome:
4.1.1- Define and identify differences between cheques, bills of exchange and
promissory notes.




When it is payable after sight
presentment for acceptance is necessary to fix the date for payment.
Where it is expressly stipulated that the bill shall be presented for
acceptance.
Where it is payable elsewhere, other than at the place of residence or
business of the drawee.
Marking Grid
Listing instances where presentment is compulsory – 1 mark each
1.16.
Learning Outcome:
6.1.3 - Explain the applicable principles in a contract of insurance relating to
uberrimae fidei .curable interest and indemnity (including total and partial
insurance)
•
“Uberrimae fidei” or “Utmost Good Faith”
-
A very important aspect of all contracts of insurance is that a duty is
imposed on the person applying for the insurance cover, to exercise
“utmost good faith” in all his declarations to the insurer. In Latin, “utmost
good faith” is referred to as “uberrimae fidei”.
10
•
The Principle
- This principal of “uberrimae fidei” means that the person seeking the
insurance, owes a duty to disclose to the insurer, every material fact,
which he knows or ought to know, about the insurance, so that the
insurer can properly evaluate the risk that he is undertaking.
-
The failure to disclose a material fact by the person seeking the
insurance, gives the insurer the right to reject payment on the policy i.e.
such failure makes the policy voidable.
-
Material Facts - A fact is material, if it can influence the judgment of a
prudent insurer, in deciding whether to accept the risk or not, and in the
event the risk is accepted in fixing the premium.
Marking Grid
For defining the term “uberrimae fidei”
For explaining its application in insurance contracts
– 1 mark
– 3 marks
1.17.
Learning Outcome:
1.4.1 Explain the regulatory role of each of these institutions:
Institute of Chartered Accountants, Sri Lanka Accounting and Auditing Standards
Monitoring Board, Securities and Exchange Commissions, Colombo Stock
Exchange, Board of Investment, Registrar of Companies, Dept. of Customs, Central
Bank (Exchange Control Department).
Colombo Stock Exchange - Regulatory Role and Main Functions



The CSE offers a variety of tools to help investors monitor trading activity
and keep the pulse of the market. It has facilities for the secondary trading
of Corporate and Government Securities.
The CSE provides a fully automated trading platform, for the participants. It
was one of the first Exchanges in the Asian Region to successfully automate
its clearing and settlement functions, with the installation of a Central
Depository and an electronic clearing and settlement system for share
transactions (in 1991), and an Automated Trading System (ATS) (in 1997).
A separate Trading System (DEX) and a separate Clearing and Settlement
mechanism is in place for debt securities. All Government Debt can be
traded through the DEX system.
11

The CSE has two main price indices, namely the All Share Price Index
(ASPI) and the Milanka Price Index (MPI). The ASPI shows the price
fluctuations of all the listed companies and covers all the traded companies
during a market day.
Marking Grid
For stating the regulatory role and main functions – 4 marks
1.18.
Learning Outcome:
9.1.2 Explain the process of international commercial dispute resolution.




Matters relating to members of the Armed Services and Police.
Appointments, transfers, dismissals or disciplinary control of public
officers.
Matters relating to the Auditor General.
Matters relating to the Commissioner of Elections
Marking Grid
For listing the ways that a contract of sale may be formulated - 4 marks
1.10.
Learning Outcome:
7.3.3 Identify facilities to be provided by employers under the Shop & Office
Act.
Facilities to be provided by the Employer
To provide suitable and sufficient;
• Means of lighting and ventilation,
• Facilities for employees to take their meals in the premises.
• To provide sanitary conveniences and washing facilities.
• To provide seats behind the counter for women shop assistants.
• To maintain the workplace in good repair and order.
Marking Grid
For listing the facilities – 4 marks
12
SECTION 2
Answer .02
Learning Outcome:
2.1.1 Explain the requisites of a valid contract (offer and acceptance,
intention to create legal relations, consideration, capacity and form.
Definition of a contract, agreement, capacity to contract, form of contracts,
reality of consent.
1.
Yes, the day the letter was posted to the post box - 8th January
Marking Grid
For identifying and stating that there is a valid acceptance -2 marks
2.
Discuss the postal rule with Adams Vs Lindsel case facts “acceptance by post”,
relate the court decision; Adams v Lindsel (1818) 106 ER 250
Facts of the case: The defendant wrote to the claimant offering to sell them some
wool and asking for a reply 'in the course of post'. The letter was delayed in the post.
On receiving the letter the claimant posted a letter of acceptance the same day.
However, due to the delay the defendant's had assumed the claimant was not
interested in the wool and sold it on to a third party. The claimant sued for breach
of contract.
Held: There was a valid contract which came in to existence the moment the letter
of acceptance was placed in the post box.
This case established the postal rule. This applies where post is the agreed form of
communication between the parties and the letter of acceptance is correctly
addressed and carries the right postage stamp. The acceptance then becomes
effective when the letter is posted.
Marking Grid
For explaining the postal rule in detail - 4 marks
13
3.
By Revocation
The basic requirement is that a revocation requires communication to the offeree
of the fact that the offer is no longer open. Under the postal rule, although an
acceptance is effective upon posting - a revocation is only effective UPON RECEIPT.
Byrne v Van Tienhoven - revocation requires communication (1880) LR 5 CPD 344
Common Pleas Div
• The court took the view that a revocation is not effective prior to its
communication, and that the posting of a letter of revocation does not constitute
communication of it.
• The rationale is that a state of mind not notified cannot be regarded in dealings.
The principle is that the writer of an offer impliedly accepts that a posted answer
will be sufficient - and that the post office will act as agent for the purpose therefore delivery to the post office is delivery to the other party.
• But this principle is not applicable to the withdrawal of an offer. Any other view
would lead to great inconvenience. Nobody could act on an acceptance until a
further stage had been gone through of confirming that a revocation had not been
sent to them in the meantime.
• The Communication of the revocation, can be made either by the offeror, or by
a source which the offeree believes to be reliable
Marking Grid
For discussing the principles relating to revocation of an offer - 4 marks
14
Answer .03
Learning Outcome:
5.1.1 Explain the circumstances under which a relationship of Principal-Agent
would be recognized by mutual agreement, by ratification, by necessity and by
estoppels.
5.3.1 State the duties of an agent towards principal
1.
The principal is the one who will have to ratify the transaction. Looking at the
transaction, the Principal will not ratify the transaction due to the secret profit the
agent got.
Requirements for the ratification
• The agent must purport to act as agent for a principal who is in
contemplation:
• There should be an act capable of ratification
• The principal must be in existence
• The principal must be competent to contract:
• The principal must have full knowledge of material facts:
• Whole transaction must be ratified within reasonable time:
• Ratification must not injure a third person
Marking Grid
For explaining the requirements of a ratification – 7 marks
2.
This could be considered as a secret profit. Any advantage, any benefit, is
considered as a secret profit which is not disclosed to the principal. Agent’s
responsibility to inform any additional gains to the Principal since it is principal’s
money. If not the principal can cancel the agency relationship and claim damages
from the agent.
Marking Grid
For explaining the principle on secret profits – 3 marks
15
Answer. 04
Learning Outcome:
6.2.1 Explain concepts of Hire- Purchase.
6.3.1 Explain the concept of Leasing
6.3.3 Explain the default by Lessee and remedies available for Lessor
1.
Lease:
In simple words, Lease is a financial contract between the business customer (user)
and the equipment supplier (normally owner) for using a particular
asset/equipment over a period of time against the periodic payments called “Lease
rentals”.
Lease generally involves two parties i.e. the lessor (owner) and the lessee (user).
Under this arrangement, the lessor transfers the right to use to the lessee in return
of the lease rentals agreed upon. Lease agreement can be made flexible enough to
meet the financial requirements of both the parties.
Hire Purchase:
Hire Purchase is a kind of installment purchase where the businessman (hirer)
agrees to pay the cost of the equipment in different installments over a period of
time. This installment covers the principal amount and the interest cost towards the
purchase of an asset for the period the asset is utilized. The hirer gets the possession
of the asset as soon as the hire purchase agreement is signed. The hirer becomes
the owner of the equipment after the last payment is made. The hirer has the right
to terminate the agreement any time before taking the title or the ownership of the
asset.
Difference between Lease and Hire Purchase:
• Ownership of the Asset: In lease, ownership lies with the lessor. The lessee
has the right to use the equipment and does not have an option to purchase.
Whereas in hire purchase, the hirer has the option to purchase. The hirer
becomes the owner of the asset/equipment immediately after the last
installment is paid.
• Depreciation: In lease financing, the depreciation is claimed as an expense in
the books of lessor. On the other hand, the depreciation claim is allowed to the
hirer in case of hire purchase transaction.
16
• Rental Payments: The lease rentals cover the cost of using an asset.
Normally, it is derived with the cost of an asset over the asset life. In case of hire
purchase, installment is inclusive of the principal amount and the interest for
the time period the asset is utilized.
• Duration: Generally lease agreements are done for longer duration and for
bigger assets like land, property etc. Hire Purchase agreements are done mostly
for shorter duration and cheaper assets like hiring a car, machinery etc.
• Tax Impact: In lease agreement, the total lease rentals are shown as
expenditure by the lessee. In hire purchase, the hirer claims the depreciation of
asset as an expense.
• Repairs and Maintenance: Repairs and maintenance of the asset in financial
lease is the responsibility of the lessee but in operating lease, it is the
responsibility of the lessor. In hire purchase, the responsibility lies with the
hirer.
• Extent of Finance: Lease financing can be called the complete financing
option in which no down payments are required but in case of hire purchase,
the normally 20 to 25 % margin money is required to be paid upfront by the
hirer. Therefore, we call it a partial finance like loans etc.
• The option of lease finance or the hire purchase can be opted by the
businessmen but they should be analyzed properly as to how much the option
suits to the business requirement and situations.
Marking Grid
For explaining the terms finance lease and hire purchase -2 marks
For explaining the difference between a finance lease contract and a hire
purchase contract - 4 marks
17
2.
Rights available for a lessor against the lessee over the lease contract.
• Cancel the lease contract.
• Proceed respecting goods not identified to the lease contract.
• Withhold delivery of the goods and take possession of goods previously
delivered.
• Stop delivery of the goods by any bailee.
• Dispose of the goods and recover damages, or retain the goods and recover
damages, or in a proper case recover rent.
• Exercise any other rights or pursue any other remedies provided in the lease
contract.
Marking Grid
For discussing the rights available for a lessor against the lessee over the
lease contract - 4 marks
Answer. 05
Learning Outcome:
3.3.1 Discuss the time at which there is a passing of risk and a transfer of
title (unascertained goods, reservation of title, instalment deliveries, sales by
auction, sale by person not the owner).
3.4.1 Explain the remedies which are available to a buyer and seller, including
rights of an “unpaid seller”.
1.
In this scenario, Warren did not signify to Karen, his direct acceptance or
refusal to buy these jewels.
But the fact that Warren mortgaged these jewels to Morty, amounts to
Warren adopting the purchase of the jewels from Karen.
Therefore the property in the jewels, has passed to Warren.
Similar facts were discussed in the decided case, Kirham v Attenborough
[1897] 1 Q.B. 201
Marking Grid
One mark for each point (maximum 4 marks)
18
2.
In the given scenario, Warren did not give his consent to Morty to sell the
jewels to anyone, leave alone Jonny.
Under the Sale of Goods Ordinance, Jonny will eventually get the same title
to the jewels, as what Morty had.
Since Morty did not have a good title to these jewels, Morty too will not get
a good title to them.
Therefore Jonny does not get the ownership of these jewels.
Marking Grid
One mark for each point (maximum 4 marks)
3.
In this scenario, Karen is an un-paid seller.
Though an un-paid seller has many rights under the Sale of Goods
Ordinance, given the facts of the scenario, the right applicable to Karen is
the right to maintain an action against Warren, for the recovery of the sales
price for these jewels.
Marking Grid
Two marks for the points
19