Question

1) Growth Ltd.’s Statement of Income for accounting purposes reflects a deduction of $26,000 for professional fees during its December 31, 2020 taxation year. This amount is comprised of the following:

Legal fees for a 10-year bank loan $11,000

Legal fees to defend a lawsuit for a failure to deliver goods on a timely basis 8,100

Legal fees related to the purchase of equipment 6,900

Given only this limited information, by what amount is Growth Ltd.’s net income after tax (“NIAT”) for accounting purposes INCREASED to determine its income from a business (“profit”) for income tax purposes for its December 31, 2020 taxation year,? (2005 CPAO)

(a) $17,900

(b) $16,800

(c) $15,700

(d) $ 8,800

Answer 1

Answer :- (a) $17,900

Reason:-

To determine income from business for income tax purpose, expenses directly in connection with business, i.e., in relation to operating activity are only allowed as deduction. Analysing the current situation,

1. Legal fee for 10-year bank loan-$11,000 :- not deductible as it is related to financing activity hence, need to ad back

2. Legal fees to defend a lawsuit for a failure to deliver goods on a timely basis 8,100 :- delivering goods an payment of of fines, damages etc. related to failure in performance are related to operating activity. Hence allowed as expense. no need to add back.

3.Legal fees related to the purchase of equipment $ 6,900 :- activity is typical case of investing and hence can't be allowed as deduction from profit. Therefore, need to add back.

So, Add back $11,000 & $6,900 = $17,900