Quite a number of businesses and taxpayers around the world have issues regarding expenses that are often denied by tax administration. Currently, there are number of case laws which have attempted to address specific issues, such as deductibility of expenses like damages, expenses on travel from home to work place and back home et cetera.
What expenses are categorized as deductible? In principle, expenses incurred for the production of taxable business incomes have to be recognized by allowing their deduction.
Characteristics of expenses under Rwanda’s Income Tax Act
The charging provision for the deductible expenses is article 21 of Law No. 16/2005 of 18/08/2005, on direct taxes on income as amended to date. This provision outlines a couple of conditions that have to be fulfilled in order for an expense to be characterized as “deductible” or allowable deduction; it should:
1-Be incurred for and the direct purpose of, and in the normal course of the business;
2-Represent a real expense with support documents;
3-Decrease net assets of the business;
4-Relate to activities related to the tax period in which they are incurred.
However, article 22 of the same law outlines such expenses that do not constitute deducible expense, which are:
-Cash bonuses attendance fees and other similar benefits given to members of the board;
-Dividends declared and paid out of profit shares;
-Fines and similar penalties;
-Donations/gifts exceeding 1% of the turnover, or donations given to profit making entities,
-Reserve allowances, savings and other and other special purpose funds;
-Income tax paid in accordance to the tax laws, or tax paid abroad and recoverable Value Added Tax;
-Expenses paid on business over heads, whose business use cannot practically be separated private use, such as telephone, electricity and fuel, such rates are determined by the Commissioner General. Note that this part is not totally denied, because as you can see the Commissioner General sets out guidelines for their deductibility.
NB: The prohibition rules in article 22 above override the general rules on deductibility mentioned in article 21. Generally, it should be understood that deductible expenses should be restricted to such expenses which are incurred while producing taxable income.
There are other deductible expenses which are mentioned in article 27 of the above income tax law. Such are expenses related to “training and research” However, the provision of the law, goes further to state that such training and research activities are those that promote business activities in the tax period,
The other issue which we do not find necessary to discuss here is the nature of training vis-à-vis the business that is covered under the above article.
This training and research should be inline with the nature of business carried out; such that a law firm may not claim a deductible expense, for a research carried out on mining, while arguably, a law firm can be allowed a deduction for training of an accountant, if such training is intended to facilitate the attorneys in that firm to carry out their business. Needless to mention is that the principle of deductibility, benefits only businesses that keep book of accounts, and which do not fall under the lump sum regime.
The bad debt is another expense that is a deductible under the income tax law (see article 28 of the above law). Taxpayers are aware that when they file their tax returns, they are required to indicate their debtors, i.e. persons who owe them money.
There are a couple of conditions governing this kind of deduction. One of them is to prove insolvency of your debtor. Insolvency is determined by competent courts, meaning that a taxpayer has to ensure the court declares such a debtor as insolvent. When does such an expense become deductable, is it the year in which the debt was incurred or the period in which the court declared him insolvent?
The author believes that to ensure proper timing, deduction will be allowed in the period the courts declare the debtor insolvent, since this could be several years, when the actual tax period to which the debt relates has already passed.
Why are expenses related to fines and penalties denied? Fines and penalties are not deductible as we indicated above. The reason for this is that once they are allowed, then provisions of the law which sanction certain acts would be rendered ineffective. In this case, a taxpayer would for instance not mind filing a tax return on time, since he would be sure that even if a fine applies, the impact of such fine would be compensated as a deductible expense.
However, in Canada, an egg famer was penalized for exceeding a given quota, (he produced more eggs than he was supposed to produce). The penalty for the excess production was allowed as deductible by courts because what the famer had done was seen as a minor offence.
How are expenses incurred on an illegal business or bribes treated? This is not permissible in jurisdictions like Rwanda, where the policy condemns corruption. The purpose of this is to ensure that “public order” is not offended. Paradoxically, in some countries, bribes may be deductible if they are incurred for the sake of business; examples of such countries that permit their deduction are Japan and France.
Expenses you can claim over time
Article 24 provides for depreciation allowance and their rates of depreciation. The Minister who has finance in his attributions may revise the depreciation rates, while the Commissioner General of Rwanda Revenue Authority is entrusted with the duty to determine depreciation rates for assets of information and telecommunications systems whose lifespan exceeds ten years.
The cost of assets that have a longer life are called capital expenses. These assets have a limited life expectancy (effective life) and can reasonably be expected to decline in value over the time you use them.
They are called depreciating assets, and include:
•Plant, equipment etc.
However, some items like land and items of trading stock are not depreciating assets. Improvements to land and fixtures on land, such as putting up fences on that land, may be depreciating assets.
Depreciation of the above equipment start when they are first put to business use in the production of incomes that are taxable. If you keep your assets and they depreciate without using them, then you cannot benefit from deduction for such depreciation. Generally, depreciation has to be spread across the life span of such capital assets.
This topic on ‘deductible expenses’ has a lot of issues such as loss carry forward, expenses related to travel, exempt incomes, loss on foreign exchange, investment allowance etc. We can not discuss them in just one article.
NB: Readers are cautioned that this is not a legal advice and should not be cited as an authority. However, this attempts to provide businesses with a better understanding of how deductible expenses affect the tax payable, and to create awareness among businesses in regard to their rights. This is also aimed at facilitating readers to appreciate the policy considerations behind such denial or allowable deductions and above all, to enhance compliance among businesses.
The author is a tax lawyer and a managing partner of Millennium Law chambers, who is accessible via the following email and website