Accounting For Income Tax Provision

By Dr. Kennedy Iwundu, Chairman of the Chartered Institute of Taxation of Nigeria (CITN) Abuja District

TABLE OF CONTENT

1.0 Introduction

1.1 Limitation of presentation

1.2 Definition of term (Income Tax Provision)

1.3 IAS 37 — Provisions, Contingent Liabilities and Contingent Assets

1.4 Guide for Computation of income tax provision

1.5 Illustration

1.6 Advantages and disadvantages of income tax provision

1.7 Conclusion

1.8 Recommendations

References

Learning objectives

At the end of this presentation, participants expected to know the following:-

Understand provision of income tax meaning

Assimilate computation provision of income tax

Know the advantages and disadvantages of provision of income tax

INTRODUCTION
Many companies in Nigeria do not make provision for corporate taxation and as a result, when it is time to file tax returns and pay taxes it becomes difficult for the companies to comply.

Where management of a company fails to make provision for corporate income tax, it is always difficult for the company to fulfil her tax payment obligations. Provision for taxation does not translate to the actual company income tax a company is obligated to pay based on the tax laws.

There is a time gap between the provision made and payment of the actual tax liability.

So it services as a some of short term finance during the intermediate period. Provision for taxation provides funds for financing working capital, it does not involve any cost, it has no legal formalities and it does not involve any issue-related cost.

LIMITATION OF PRESENTATION
In this paper presentation, Accounting for tax provision is limited to corporate tax (Company Income Tax)

1.2 DEFINITION OF TERM (INCOME TAX PROVISION)

A tax provision is the estimated amount of income tax that a company is legally expected to pay to the FIRS for the current year. It is just one type of provision that corporate finance departments set aside to cover a probable future expense. Other types of provisions a business typically accounts for include bad debts, depreciation, product warranties, pensions, and sales allowances.

Tax provisions are considered current tax liabilities for the purpose of accounting because they are amounts earmarked for taxes to be paid in the current year. Although the basic definition sounds simple, what’s not always simple is how to prepare for tax provision calculation in a way that is best for the business while being fast, accurate, and defendable. Estimating each year’s tax provision is not a menial task and can require a great deal of time and effort for corporate tax departments.

1.3 TAX PROVISION ACCOUNTING IN ACCORDANCE WITH IAS 37

IAS 37 – Provisions, Contingent Liabilities and Contingent Assets.

IAS 37 outlines the accounting for provisions (liabilities of uncertain timing or amount), together with contingent assets (possible assets) and contingent liabilities (possible obligations and present obligations that are not probable or not reliably measurable). Provisions are measured at the best estimate (including risks and uncertainties) of the expenditure required to settle the present obligation, and reflects the present value of expenditures required to settle the obligation where the time value of money is material.

1.4 GUIDE FOR COMPUTATION OF INCOME TAX PROVISION

– Estimate your company’s net income for the financial year. This refers to the company’s net taxable income for the year. Accounting rules direct accountants on how to calculate a company’s net annual income for tax provisions.

– Calculate the permanent differences. There are expenses that should be included in your calculations allowed in accounting but aren’t allowed for tax purposes. This difference in calculations leads to a discrepancy in the final results that needs to be accounted for.

These differences are never reversed, and since you can’t register these expenses for income tax purposes, they’re considered permanent. Common examples include penalties, fines, municipal bond interest, and life insurance proceeds.

Calculate your temporary differences. These refer to expenses that can be accounted for in accounting rule or for income tax purposes but not both in one year. You can calculate this by comparing the difference between the accounting calculations of your company’s current year balance sheet and your income tax calculations.
These differences are eventually reversed, so they’re referred to as temporary. Common examples include depreciation and expenses that were incurred but not yet paid.

Apply your tax credits and account for net operating losses (NOL). Tax credits and NOL are deducted from the net taxable income. The amount you’re left with is the amount you actually pay taxes on. Some of these may be carry forwards from the prior year.

Apply the current tax rate. You can do this by multiplying your current year’s taxable income by the current federal corporate tax rate, which yields your company’s current tax expense for the income tax provision.

1.5 ILLUSTRATION

Calculation Example of Provision for Income Tax

The following is an example to understand the concept in a better manner.

ABC ltd is the company that sells automobile spare parts. The company reports following figures for the accounting year ending on December 31st, 2023. Suppose the applicable income tax rate on the company for the year under consideration is 30%. Calculate the provision for taxation using the given figures for the accounting year ending on December 31st, 2023

Revenue: N180 Million
Cost of Sales: N140 Million
Administrative Expenses: N35 Million
Distribution Expenses: N15 Million
Interest Expense: N1.1 Million
Rental Income: N7 Million
Deferred Revenue for 2022 N20 Million
Return inwards/Refunds N11 Million

Solution

In order to calculate it, first of all, the profit before tax will be calculated from the details given.

Statement of Calculation of Profit before taxes

Particulars Amount
Current Year Revenue 180,000,000
Add Deferred Revenue 20,000,000
Gross Revenue 200,000,000
Less Cost of Sales (140,000,000)
Gross Profit 60,000,000
Less Refunds (11,000,000)
49,000,000
Add: Other Incomes
Rental Income 7,000,000
56,000,000
Less: Expenses
Administrative Expenses (35,000,000)
Distribution Expenses (15,000,000)
Operating Profit 6,000,000
Less: Finance Expenses
Interest expenses (1,100,000)
Profit Before Tax 4,900,000
Tax Rate 30%
Provision for Income Tax 1,470,000

N4,900,000 X 30%

Provision for Income Tax = N1,470,000

Thus the provision of the income tax for the accounting year ending on December 31st, 2013, for the company ABC ltd is N1,470,000

OPTION 2: PROVISION FOR TAXATION

APPLICATION OF MINIMUM TAX BASED ON SECTION 33 OF COMPANY INCOME TAX ACT (CITA)

Section 33 of CITA made it mandatory that a company must pay minimum tax even if that company has declare loss in as much as the company has more than 25 million turnover in a year and has operated for up to 4 years and above.

The minimum tax rate is 0.5% of the turnover.

For ABC Ltd, the minimum tax will be 0.5% of N200,000,000 this means that the company can provide N1,000,000 to file for company income tax returns.

Note

The provision of the above minimum tax will enable the company file tax returns at the interim pending tax review that will later come up for the right amount of tax to be paid by the company.

1.6 ADVANTAGES AND DISADVANTAGES OF INCOME TAX PROVISION

Advantages

The various advantages related to these are as follows –

• It is the provision that is made by the company out of its profits of the current profits in order to meet its tax obligation, which will arise in the future. However, there will be a certain time gap between the date of the making of tax provision by the company and payment date. So the company can take the opportunity of the time gap and use the provision for tax as the source of short-term finance in the intermediate period. It does not mean any extra cost to the company as well as does not involve any legal formalities.
• With the help of the provision for income tax, the company makes the provision for future liability well in advance. It will make all the stakeholders aware of the tax liability, which will arise in the future to the company.
  It is a cheaper source of finance and does not involve any cost.
  There is no obligation of payment of any cost of capital.

The disadvantages related to these are as follows:

• It is the source of finance for the company but only for the short term and cannot be used for financing the long term under the requirement of the company.
• It is possible some of the times that the company creates the excess provision for the income tax, which leads to the insufficient use of the funds of the company as that the company could have utilized funds in other productive areas.
• Short-term Finance: Provision for taxation provides funds for a very short period.
  Inefficient Utilization of Funds: Sometimes excess provision may be created which might lead to misuse of funds.

1.7 CONCLUSION
Provision for Income Tax refers to the provision which is created by the company on the income earned by it during the period under consideration as per the rate of tax applicable to the company. The company makes this provision by making adjustments to the difference of permanent as well as the temporary nature in the company’s net income for the period.

As there is a certain time gap between the date of making the provision for tax by the company and the date when it is paid, the company can take the opportunity of the time gap and use the provision for tax as the source of the short-term finance in the intermediate period. However, it is the source of finance for the company but only for the short term and cannot be used for financing the long term under the requirement of the company. Also, it is possible some of the times that the company creates the excess provision for the income tax, which may lead to the insufficient use of the funds of the company.

1.8 RECOMMENDATIONS

Get the right data
Ensuring that the data you have consolidated is accurate and representative of your company’s transactions is crucial. This can be collected from your company’s financial statements, which should always be up to date.

Use a tax provision checklist
A tax provision checklist can help you tick off all the items you need to account for while calculating your estimated tax amount. Be sure to consider these three categories:

iii. Review the framework for risk assessment and control

– Internal risk factors

– External risk factors

– Standard reporting package

Check the accounting requirements for the measurement of income taxes
– Unrecognized tax benefit analysis

– Current income tax procedure

– Deferred income tax procedure

– Valuation allowance analysis

– Special areas for income taxes

Consider the relevant requirements for the presentation and disclosure of income taxes
– Accounting for income taxes in the interim period

– Financial statement presentation checklist

– Income tax disclosure checklist

REFERENCES

Kennedy Iwundu (2024) Contemporary Issues on Taxation in Nigeria Volume 2 . WOCA Printing Hub.
Thomson Reuters (2023) What is provision for income tax and how do you calculate it?. (Tax & Accounting) Thomson Reuters Publications
Upwork (2022) What is tax provision and how can you calculate it?. The upwork team publications
Provision for Income Tax (2024) Wallstreetmojo Team. Wallstreet mojo publications
Jennifer Willamson (2023) what is the income tax provision and hot to calculate it?. Kreston Global Publications

By Dr Kennedy Iwundu

[CHAIRMAN, CHARTERED INSTITUTE OF TAXATION OF NIGERIA (CITN) ABUJA DISTRICT]