Income from Property & Business

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Income from Property & Business — Key ACCA/CA Pakistan Facts

Property Income: Section 15 (ITO 2001) — Rental income from land, buildings, or furniture. Business Income: Section 16 (ITO 2001) — Profits from any trade, profession, or vocation.

Property Income — Section 15:

• Gross income = Total rent receivable (including vacancy allowance, if any)
• Deductions (Section 16): Municipal/local taxes (if not paid by tenant), insurance, repair costs (actual, not capitalized), depreciation on furniture/fixtures
• Standard deduction: 5% of gross rent allowed in lieu of all expenses (except municipal taxes paid)

Business Income — Section 16:

• Gross receipts less admissible expenses = Taxable profit
• Admissible expenses: Those wholly, exclusively, and necessarily incurred in earning the income
• Inadmissible expenses: Personal expenses, capital expenditure, fines, donations (except under Section 60C), unrealized losses

Accounting vs. Tax: Tax profit ≠ Accounting profit. Items like depreciation (tax: wear & tear allowance), provision for doubtful debts, and unrealized gains/losses are treated differently.

⚡ Exam Tip: The most frequently tested adjustment is depreciation vs. tax wear & tear. Tax wear & tear is based on asset life rates in the 5th Schedule, not the company’s accounting depreciation rate.

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Income from Property & Business — ACCA/CA Pakistan Study Guide

Income from Property — Section 15

Chargeability: Income from the use of land, buildings, or any machinery, plant, or equipment is chargeable under this head.

Gross Amount Receivable:

• Rent, minerals, or any consideration received for the use of property
• Vacancy allowance (amount which the owner could have earned had the property been tenanted) is included in gross income even if not received
• Advance rent (premiums, key money) is spread over the period to which it relates

Deductions (Section 16 — applicable to all heads): The general rule: Only expenses wholly, exclusively, and necessarily incurred in earning income are deductible. The standard deduction under Section 16(1)(xa) is a simplified alternative:

Standard Deduction (Section 16(1)(xa)):

• A flat 5% of gross rental income is allowed as a standard deduction
• This is in lieu of all expenses except:
  • Municipal/local taxes paid by the landlord (not recoverable from tenant)
  • Insurance premiums
  • Interest on borrowed capital (if property is mortgaged/financed)

Depreciation (Tax Wear & Tear — 5th Schedule): Furniture, fixtures, and equipment used in rental activity: Depreciated at 15% per annum on a diminishing balance basis.

Income from Business — Section 16

Definition of Business (Section 2(13)): “Business” includes any trade, commerce, manufacture, profession, vocation, or any other activity conducted for a profit. It covers:

• Commercial activities (trading, manufacturing)
• Service businesses (consultancy, legal, medical practice)
• Profession (CA, lawyer, doctor)

Chargeability: Business income is taxed on the profit computed as per the tax law, not accounting profit.

Admissible vs. Inadmissible Deductions:

Admissible	Inadmissible
Operating expenses (rent, salaries, utilities)	Capital expenditure (acquisition of assets)
Depreciation/Tax wear & tear	Personal expenses of owner
Interest on borrowed capital (for business)	Fines, penalties, taxes paid (though certain provincial taxes allowed)
Bad debts (written off, specific provision)	Donations (except under Section 60C)
Insurance premium on business assets	Loss on disposal of capital assets (use Capital Gains)
Repair and maintenance	Entertainment expenses (only 50% deductible for companies under certain conditions)

⚡ Key Distinction: Bad debts vs. provision for doubtful debts. A specific debt written off as irrecoverable in the books is deductible — but a general provision for doubtful debts is not deductible (this is a common exam trap).

Tax Wear & Tear vs. Accounting Depreciation

This is one of the most important adjustments in tax computations:

Feature	Tax Wear & Tear (5th Schedule)	Accounting Depreciation (IAS 16)
Method	Diminishing balance (usually)	Straight-line, reducing balance, etc.
Rate	Prescribed by Rules (e.g., Building 5%, Plant & Machinery 15%, Motor Vehicles 20%)	As per company’s accounting policy
Full year vs. Half year	Full year if used ≥ 180 days; half year if < 180 days	Pro-rata based on date of addition
Residual value	5% of original cost (minimum residual)	As per company’s estimate

Tax Wear & Tear Rates (selected):

• Buildings: 10% per annum (straight-line or diminishing — option with taxpayer)
• Furniture and fixtures: 15% per annum
• Plant and machinery: 15% per annum
• Motor vehicles: 20% per annum
• Computers/hardware: 30% per annum

⚡ Exam Tip: If a question provides accounting profit and asks for taxable profit, you must adjust for: (1) Tax wear & tear vs. accounting depreciation, (2) Disallowed expenses (donations, fines, personal expenses), (3) Timing differences (prepaid expenses, accruals), (4) Capital vs. revenue items.

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Income from Property & Business — Comprehensive ACCA/CA Pakistan Notes

Income from Property — Section 15 (Detailed)

Scope and Chargeability: Section 15 charges income from the ownership of property — whether the property is let out or self-occupied. For self-occupied property, the notional rental income is generally exempt under the First Schedule (for one residential house only). However, for business use of own property, the owner is deemed to have received rent equal to the annual rental value.

Key Components:

1. Rent: Actual rent received or receivable
2. Advance Rent (Premiums): Premiums for granting a lease are spread over the lease term
3. Key Money: Lump sum non-refundable payments — taxable in the year received
4. Vacancy Allowance: Notional rent for the period the property was vacant and available for letting — included in gross income of the owner

Exemption under First Schedule:

• One residential house used for own residence — exempt from property income tax (not from capital gains)
• Agricultural income from land used for agricultural purposes — exempt under Section 41 (but note the partial rebate provisions for individuals)

Treatment of Property Expenses: If the standard deduction (5%) is claimed, no other expenses are deductible. If actual expenses are higher, the taxpayer may opt for actual expense deduction — but must maintain proper records and claim only items that qualify under Section 16.

Example — Property Income Computation:

Gross Rent Receivable:            PKR 1,200,000
Less: Vacancy allowance (2 months unoccupied):  PKR 200,000
Net Rent:                          PKR 1,000,000
Less: Standard deduction (5%):      PKR 50,000
Less: Municipal tax paid (not recoverable):    PKR 15,000
Taxable Property Income:           PKR 935,000

Income from Business — Section 16 (Detailed)

Basis of Computation: Business income is computed on the basis of accounts kept on the accrual basis (unless cash basis is applicable to certain small taxpayers). The starting point is the accounting profit/loss as per the financial statements, adjusted for tax provisions.

Framework for Adjustments:

Accounting Profit (Net)                    PKR X
Add Back: Disallowed Expenses
  - Accounting depreciation               PKR X
  - Provisions (doubtful debts, etc.)     PKR X
  - Personal expenses                     PKR X
  - Fines and penalties                    PKR X
  - Donation (excess of Section 60C limit) PKR X
  - Capital expenditure                   PKR X
  - Tax & Fine paid (certain items)        PKR X
Less: Tax Allowable Items not in Accounts
  - Tax wear & tear (add back: less = more deduction) 
                                           PKR (X)
  - Bad debts actually written off        PKR (X)
  - Impaired assets (specific provision)  PKR (X)
  - Prior period items (tax treatment)    PKR (X)
= Taxable Business Income                  PKR X

Capital vs. Revenue Expenditure

This is a critical distinction that determines deductibility:

Capital Expenditure (NOT deductible):

• Purchase of fixed assets (land, building, plant, machinery)
• Cost of improving/enhancing an asset (capital improvement)
• Initial_setup_costs of a business
• Legal fees for acquiring an asset

Revenue Expenditure (Deductible):

• Day-to-day operating expenses (salaries, rent, utilities)
• Repair and maintenance (not improvement) of existing assets
• Consumables and stores
• Routine professional fees

⚡ Common Mistake: Students incorrectly treat all professional fees as deductible. Legal fees for defending a business’s legal rights (e.g., suing a debtor) are revenue and deductible. Legal fees for acquiring a business or asset are capital and not deductible.

Wear and Tear Allowance — Detailed Rules (5th Schedule)

General Principle: Wear and Tear (W&T) is allowed on assets used in the business. The asset must be:

1. Owned by the taxpayer (or subject to a lease agreement)
2. Used in the business (not idle or used for personal purposes)
3. Functional (not decorative or aesthetic)

Depreciation Methods:

Method 1 — Straight Line (Equal Annual Installments):

W&T = (Cost − Residual Value) / Useful Life

Method 2 — Diminishing Balance:

W&T = Opening WDV × Rate%

This is the more commonly used method in Pakistan. The WDV at year end = Opening WDV − W&T.

Rules for Additions:

• If asset is used ≥ 180 days in the year: Full year’s W&T
• If asset is used < 180 days in the year: Half year’s W&T
• Once allowed full W&T in the year of addition, half-year rule does not apply in subsequent years

Disposal of Assets: When a depreciated asset is sold:

• Taxable gain/loss = Sale proceeds − (WDV at date of disposal)
• This gain/loss is not a capital gain — it is treated as a business income/loss item
• If sold for more than WDV: Taxable income
• If sold for less than WDV: Deductible loss (only if the asset was used for business)

⚡ Common Mistake: When computing tax on business income, students often forget to include the profit/loss on disposal of fixed assets as a separate line item. This is taxable/deductible in the year of disposal.

Special Topics

Development Expenditure (Section 24): Expenditure on land development (clearing, leveling, road-making) is deductible in the year it is incurred. However, if the land is subsequently sold, the cost of development is added to the cost of acquisition (not expensed twice).

Pre-Commencement Expenses: Expenditure incurred before the commencement of business is capital in nature and not deductible. However, preliminary expenses (legal, accounting, registration fees) incurred before the start of a new business may be amortized under Section 25 — usually over a period of years.

Bonus/Depreciation on Revaluation: When an asset is revalued in accounting books and extra depreciation is claimed on the revalued amount — only the depreciation based on original cost is deductible for tax purposes. The extra accounting depreciation on revaluation surplus is not deductible.

Interaction Between Property and Business Income

A taxpayer may have both property income and business income. These are computed separately under their respective heads and then aggregated for the final tax computation. Losses from one head cannot be set off against profits of another head — except for AOPs where set-off is permitted within the AOP.

⚡ Exam Tip: For ACCA exams, questions often require a complete tax computation from a given profit and loss account with several adjustments. Always look for: (1) Disallowed expenses, (2) Wear & tear vs. accounting depreciation difference, (3) Provisions and prepayments, (4) Non-business income (e.g., interest income) that belongs to a different head.

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