How to approach a computational question for a sole trader

This article is relevant to those of you sitting the TX-MWI exam in June 2023 or December 2023 and is based on tax legislation as it applies to the tax year 2022–23.

Please note: Students should be aware that exams in June and December 2023 will be based on legislation passed by the previous September (ie September 2022) and so will incorporate the changes made to the tax rules in Malawi in April 2022 but not those changes which have been enacted in April 2023.

In the TX-MWI exam a candidate can improve their chance of a pass if they are able to complete computational questions for traders, partners and companies. Where candidates have not been able to attend a formal class there are certain key principles which should help to gain marks.

Where a question requires the adjustment of profits, the following will often be included as a note to the requirements:

• Which figure to use to start the computation.
• If you should list the items referred to in the scenario, indicating by the use of zero (0) any items which do not require adjustment.

This approach has been adopted so that candidates maximise available time, and to help them score full marks.

In this article we will look at an example of this type of question for a sole trader. The example shown is based on an extract from a published sample exam updated to reflect the legislation applicable for exams in June and December 2023.

This scenario relates to two requirements

The following information is available for John for the year to 31 March 2023.

John’s business
John operates an unincorporated business as an agricultural merchant. As he is not involved in its operations daily, he employs a manager to run the business.

The results for the business for the year to 31 March 2023 are as follows:

Notes:

1. Fringe benefits relates to benefits provided to the manager
2. Travel expenses include an amount of K800,000 relating to expenses incurred by John, when he was on holiday with his family
3. Bad debts relate to amounts not recovered from sales of produce amounting to K100,000. The balance is a provision of 1 % of the debtor balances
4. Rent costs are for rental of warehouse. The rental is at K1,800,000 per annum. The amount charged to the income statement is the amount which was paid during the period
5. Transport costs include K275,000 being fuel costs for private use by John
6. School fees are for John’s son
7. Interest received includes K15,000 as accrued interest not received at the end of the year

Additional information
(i) The business has the following assets which were bought during the year:

• Motor lorry at K4,500,000
• Two laptop computers at K 250,000 each and
• Furniture at K650,000

(ii) Provisional tax paid was K4,900,000

John’s employment
John was employed as a chemist at a laboratory. His earnings for the year ending 31 March 2023 including housing allowance was K49,500,000.

PAYE of K14,625,000 was deducted and paid over to the tax authorities by John’s employer.

John’s rental income
Net rental from house let out: K500,000
No withholding tax was deducted on this rental income

Requirement

(a) Calculate the taxable income of John’s agricultural merchant business for the year ending 31 March 2023.

Note: You should start your computation with the profit before tax of K18,271,600 and indicate by the use of zero (0) any items in the scenario relating to the business which do not require adjustment.             

(8 marks)

• Firstly, it is most important that you take time to read and understand the question.
  
  Read the scenario and then read the requirement carefully to ensure that you understand exactly what you are being asked to do. Time taken to read the question is an important investment to help you provide a better answer and can be the key to obtaining a pass. Unfortunately, students can rush to answer questions before they have really understood the requirement.
  
  Ensure that you follow any instructions given in the requirement, so in this instance the requirement has an additional note asking you to start your computation with the profit before tax and then adjusting this to arrive at the taxable income.
  
  By asking you to use a zero for items which do not require adjustment it is important to comply with this to obtain the available marks.
  
  
• Start with the profit before tax (PBT) of K18,271,600. In order to obtain the marks for this question it is important that you don’t start with any other figure other than the one given as a starting point.
  
  
• This figure then has to be adjusted for all the items which have been deducted but are not allowable for tax and for any income which has been added but is not taxable.
  
  
• Every item in the scenario which does not need adjustment should be indicated with a zero '0' to demonstrate that you understand the tax treatment and have not simply ignored the item. In this example here, allowable expenses are shown as 'other expenses (all allowable)' so, as the tax treatment of these has already been given in the scenario there are no marks for entering this as a zero.
  
  
• Depreciation – this is not an allowable deduction for tax, being an accounting expense for capital items and so this will have to be added back. However, there may be capital allowances which can be deducted for tax purposes – see below.
  
  
• Fringe benefits tax (FBT) – this is a tax which is paid in respect of certain benefits which an employer is liable to pay in respect of benefits provided to employees. This is not a deductible cost for tax purposes and so must be added back in your computation.
  
  
• Travel expenses – travel expenses which are wholly, exclusively and necessarily for the purposes of the business are deductible but not John’s private expenses. Therefore, because K800,000 has been deducted in arriving at the PBT of K18,271,600 it must be added back (so increasing the profit figure) since it is not an allowable expense.
  
  
• Bad debts – deductions are allowed where debts have gone bad and have been written off or where there are debts which are doubtful and are specifically provided for but there is no deduction allowed for general provisions. Therefore, the amount of K175,500 (275,500 -100,000) must be added back.
  
  
• Rent and rates – in this scenario the rent and rates is an expense of the business, however only the amount actually paid has been deducted. The amount which is allowable for tax purposes is the whole amount relevant for the accounting period (the amount which should be accrued in the financial statements). This would be K1,800,000. Therefore, the extra amount of K250,000 (1,800,000 less 1,550,000) will be deducted.
  
  
• Transport costs include some of John’s private expenses and therefore they do not meet the 'wholly, exclusively and necessarily' rule and must be added back in the computation (since that amount has already been deducted in arriving at the PBT and it is not an allowable cost).
  
  
• School fees – likewise these costs have been deducted but represent a private expense (not wholly, exclusively and necessarily for the business) and so must be added back in full.
  
  
• Drawings by John – John will be assessable to tax on the adjusted profits of the business. The drawings are simply a way in which John has extracted these profits so, in order to establish the correct amount of the business’s taxable profits, these too need to be added back in full.
  
  
• Bank interest – this is income of the business and is assessable on John. The amount to be assessed is the gross amount which is receivable for the accounting period (ie the accrued amount not the amount actually received). Therefore, this is correctly included in the PBT and does not need to be added back. However, the amount received is shown gross and in fact John will have suffered withholding tax of 20% on the amount actually received of K30,000 (45,000 – 15,000). So, the withholding tax will be deducted from the tax payable by John (which is part of requirement (b)).
  
  
• Capital allowances – as noted above, capital expenditure (such as depreciation) is not allowable for tax; instead capital allowances are given at a prescribed rate depending on the nature of the expenditure. The annual allowance rates are given in the tax tables available in the exam (see below). In this scenario a lorry, laptop computer and furniture have been purchased for the business and therefore capital allowances should be calculated on these. These assets are eligible for both initial and annual allowances; the annual allowance rates are given in the tax tables in the exam but you are expected to know the rates available to the type of asset as an initial allowance. The capital allowances are then deducted in the computation.
  
  
• We now have the tax adjusted trading profit ie the taxable income of John’s agricultural business as per the requirement.
  
  
• The detailed answer to requirement (a) is shown below.

Now let’s look at requirement (b)

(b) Calculate the tax payable by John for the year ended 31 March 2023.       

(7 marks)

The tax payable by John will be on his total income. This will include the income from his agricultural merchant business already calculated at part (a), note that candidates will be given ½ mark for their own figure from part (a) even if it was not the correct amount. To this will be added John’s employment income and his rental income.

The rates at which this will be taxed must be calculated and these are given to you in the exam. See this article outlining how these tax tables can be used. 

From that figure of tax due, the tax already paid (the provisional tax given in the scenario) and the PAYE deducted, and the tax already suffered (the withholding tax on the bank interest) will be deducted to give the tax which will be payable by John.

The detailed answer is shown below.

Written by a member of the TX-MWI examining team