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Tax Adviser Certification study materials
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Tax Adviser Certification practice questions

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Question 1Direct Tax

Under a classic corporate income tax system, which statement describes the treatment of dividends received by an individual shareholder?

  1. Dividends are included in taxable income and taxed again at the shareholder level. Correct answer.
  2. Dividends are taxed at the same rate as capital gains regardless of holding period.
  3. Dividends are taxed only if the shareholder holds the shares for more than one year.
  4. Dividends are exempt because the corporation already paid tax on its profits.

Explanation

Classical systems treat the company and the shareholder as separate taxpayers, so distributed profits bear corporate tax and then dividend tax in the shareholder's hands, producing economic double taxation. Relief mechanisms such as imputation or partial exemption exist precisely to soften this result, which confirms that the default is full inclusion and taxation at shareholder level.

Question 2Direct Tax

A company incurs a business entertainment expense of 50,000. The statutory deduction ceiling for entertainment is 60 percent of the amount incurred. What amount is deductible?

  1. 60,000
  2. 20,000
  3. 50,000
  4. 30,000 Correct answer.

Explanation

The deductible amount is the expense multiplied by the permitted percentage: 50,000 × 60% = 30,000. The remaining 20,000 is a permanent disallowance that increases taxable profit but is never deductible in a later period.

Question 3Direct Tax

Which item is generally treated as a capital expenditure rather than a currently deductible expense?

  1. Cost of extending a building by an additional floor Correct answer.
  2. Monthly rent paid for office space
  3. Replacement of a worn machine part with an identical part
  4. Annual property insurance premium

Explanation

Expenditure that creates a new asset or enlarges the income-producing capacity of an existing asset is capital in nature and is recovered through depreciation or amortization. Routine operating costs such as rent, insurance, and like-for-like repairs are matched against current-period income.

Question 4Direct Tax

A resident individual receives employment income of 80,000 and has allowable personal deductions of 20,000. The tax rate is 20 percent flat. What is the tax payable?

  1. 16,000
  2. 20,000
  3. 4,000
  4. 12,000 Correct answer.

Explanation

Taxable income equals 80,000 minus 20,000, giving 60,000, and tax at 20 percent is 12,000. Deductions reduce the base before the rate is applied, so they must not be subtracted from the computed tax.

Question 5Direct Tax

What is the primary purpose of a transfer pricing regime in direct taxation?

  1. To impose withholding tax on all cross-border service payments.
  2. To exempt foreign-source dividends from domestic tax.
  3. To prevent related parties from shifting profit between jurisdictions through non-arm's-length prices. Correct answer.
  4. To harmonize corporate tax rates among treaty partners.

Explanation

Transfer pricing rules require transactions between associated enterprises to be priced as they would be between independent parties, so that profit is allocated to the jurisdiction where value is created. This protects each country's tax base against artificial profit diversion.

Question 6Direct Tax

An individual has owned shares for eight months and sells them at a gain. Under a progressive scheduler system, the gain is treated as ordinary income unless the holding period exceeds twelve months. How is the gain characterized?

  1. As a capital gain eligible for the preferential rate.
  2. As ordinary income subject to the standard progressive rates. Correct answer.
  3. As a deferred item until the following tax year.
  4. As exempt income because the shares were sold at a profit.

Explanation

Where the law requires a minimum holding period for capital gain treatment, a shorter holding period recharacterizes the gain as ordinary income taxed at progressive rates. The eight-month period falls short of twelve months, so the preferential rate is unavailable.

Question 7Direct Tax

Which of the following best describes a withholding tax obligation in a domestic direct tax system?

  1. A tax assessed on the payer's own net profit at year end.
  2. A voluntary prepayment made by the recipient at its own discretion.
  3. A tax levied only on imports at the border.
  4. A tax the payer collects from a payment and remits on the recipient's behalf. Correct answer.

Explanation

Withholding is a collection mechanism: the party making a specified payment deducts tax at source and remits it, and the recipient generally receives credit for the amount withheld. It is not a separate tax on the payer's profit.

Question 8Direct Tax

A taxpayer's accounting profit is 500,000. Non-deductible fines of 30,000 were charged to the accounts, and a tax depreciation allowance of 80,000 exceeds accounting depreciation of 50,000. What is taxable profit?

  1. 530,000
  2. 470,000 Correct answer.
  3. 500,000
  4. 560,000

Explanation

Start from accounting profit, add back the non-deductible fines (500,000 + 30,000 = 530,000), then deduct the excess of tax over accounting depreciation (530,000 − 30,000 = 500,000), giving 500,000. The net effect is a 30,000 reduction because the depreciation timing difference outweighs the permanent add-back.

Question 9Direct Tax

A company pays a dividend out of profits on which it has already paid corporate income tax, and the shareholder receives a credit for underlying corporate tax. Which system is this?

  1. Imputation system Correct answer.
  2. Territorial exemption system
  3. Classical system
  4. Split-rate system

Explanation

An imputation system attaches a credit for corporate tax paid to the dividend, so the shareholder is taxed on the grossed-up amount and then credited, mitigating double taxation. A split-rate system instead applies different corporate rates to distributed and retained profits.

Question 10Direct Tax

A parent company receives dividends from a 100 percent-owned subsidiary. Under a participation exemption, which condition is typically required?

  1. The subsidiary must be resident in the same municipality.
  2. The subsidiary must be listed on a recognized stock exchange.
  3. The parent must hold a minimum percentage of shares for a minimum period. Correct answer.
  4. The dividend must be reinvested within the same tax year.

Explanation

Participation exemption regimes generally require a minimum shareholding percentage held for a minimum holding period, sometimes with a subject-to-tax condition on the subsidiary. These tests distinguish genuine group investment from portfolio holdings.

Question 11Direct Tax

A company leases equipment and the lease term covers 90 percent of the asset's useful life, with a bargain purchase option. How should the lease be treated for tax purposes?

  1. As a service contract with no recognition of an asset.
  2. As a finance lease, with the lessee recognizing the asset and deducting interest and depreciation. Correct answer.
  3. As a sale of the asset to the lessor with gain recognition deferred indefinitely.
  4. As an operating lease with rentals fully deductible as incurred.

Explanation

A lease transferring substantially all risks and rewards of ownership, evidenced by a term covering most of the useful life or a bargain purchase option, is a finance lease. The lessee is treated as owner for tax purposes, deducting depreciation and the finance charge rather than the rental.

Question 12Direct Tax

A resident company earns 200,000 of foreign-source income and pays 30,000 of foreign tax. Domestic tax on that income at 25 percent would be 50,000. Under ordinary credit relief with no limitation issues, what is the domestic tax payable on the foreign income?

  1. 0
  2. 30,000
  3. 20,000 Correct answer.
  4. 50,000

Explanation

Ordinary credit relief deducts foreign tax paid from domestic tax on the same income, subject to a ceiling equal to the domestic tax. Here 50,000 minus 30,000 gives 20,000 payable, and the credit is fully usable because it is below the ceiling.

Question 13Direct Tax

Which statement about tax losses carried forward is generally correct?

  1. Trading losses may be offset against future trading profits, often subject to continuity of ownership tests. Correct answer.
  2. Losses expire at the end of the loss year and are never deductible.
  3. Carried-forward losses may be offset against any category of income without restriction.
  4. Losses must be carried back before being carried forward in all systems.

Explanation

Most systems permit trading losses to be carried forward against future profits of the same trade, and many impose continuity of ownership or business tests to prevent loss trafficking. Ring-fencing and category restrictions commonly limit offset against unrelated income.

Question 14Direct Tax

An employer provides an employee with a company car used partly for private purposes. How is the benefit typically taxed?

  1. It is taxed as a capital gain when the employee eventually leaves the company.
  2. A taxable benefit is computed, often as a percentage of the car's list price, and included in employment income. Correct answer.
  3. It is entirely exempt because the car is owned by the employer.
  4. It is taxed only if the employee pays nothing for fuel.

Explanation

Private use of an employer-provided car is a benefit in kind included in employment income, commonly valued by a statutory formula based on the car's cost or list price with adjustments for private use. Employer ownership does not create exemption.

Question 15Direct Tax

A company donates to an approved charitable organization. How is the donation generally treated for corporate tax?

  1. As a tax credit against the company's tax liability in all cases.
  2. As a deductible expense subject to statutory conditions and any cap. Correct answer.
  3. As a capital expenditure amortized over five years.
  4. As a non-deductible distribution to shareholders.

Explanation

Qualified charitable donations are typically deductible in computing taxable profit, provided statutory conditions such as recipient approval and documentation are met, and sometimes subject to a cap. They are not distributions to shareholders nor a universal credit.

Question 16Direct Tax

Two affiliated companies file a consolidated tax return. Which outcome is typical?

  1. Each member's tax is computed separately with no elimination of intercompany items.
  2. Consolidation eliminates the need to compute taxable income for individual members.
  3. Intercompany dividends and gains are eliminated and losses of one member may offset profits of another. Correct answer.
  4. Consolidation is available only to companies in the same industry.

Explanation

Group consolidation eliminates intra-group transactions and allows losses of one member to be set against profits of another, producing a single group tax result. Individual members' results are still computed as the building blocks of the consolidated figure.

Question 17Direct Tax

A company sells a building for 600,000. Original cost was 500,000 and cumulative tax depreciation allowed was 120,000. What is the balancing charge or allowance, ignoring indexation?

  1. Balancing allowance of 20,000
  2. No balancing adjustment arises
  3. Balancing charge of 20,000 Correct answer.
  4. Balancing charge of 120,000

Explanation

Tax written-down value is 500,000 minus 120,000, equal to 380,000. Sale proceeds of 600,000 exceed that value by 220,000; the excess up to the original cost is a recovery of depreciation taxed as a balancing charge of 120,000, and the remaining 100,000 is a capital gain, so a balancing charge of 120,000 arises.

Question 18Direct Tax

An individual disposes of a residential property held for six years, having lived in it for four of those years. Under principal private residence relief, what portion of the gain is typically relieved?

  1. One-half, because relief is capped by statute.
  2. Four-sixths, subject to any additional deemed-occupation periods allowed by law. Correct answer.
  3. The full gain, regardless of the period of non-occupation.
  4. None, because the property was rented out at some point.

Explanation

Principal private residence relief is apportioned on a time basis over the period of ownership, so occupation for four of six years relieves four-sixths of the gain, with final-period relief and letting relief added only if the law provides. The relief is not a flat statutory fraction.

Question 19Direct Tax

A company pays royalties to a non-resident for the use of a patent. Which treatment is typical under domestic law?

  1. The royalty is taxed only in the recipient's country with no domestic obligation.
  2. The payer must withhold tax at the statutory rate on the gross royalty, subject to any treaty reduction. Correct answer.
  3. No tax arises because the payment is a business expense of the payer.
  4. The royalty is treated as a capital distribution to the non-resident.

Explanation

Royalties for the use of intellectual property are typically sourced where the property is used and are subject to withholding by the payer at the domestic statutory rate. A double tax treaty may reduce or eliminate the withholding, but that requires claiming treaty benefits.

Question 20Direct Tax

An individual sells shares at a loss and, within the same year, buys substantially identical shares. Under wash-sale-type rules, what is the usual consequence?

  1. The loss is currently deductible in full.
  2. The loss is deductible only against employment income.
  3. The loss is converted into a capital gain.
  4. The loss is disallowed or deferred, and the disallowed amount is added to the cost of the replacement shares. Correct answer.

Explanation

Wash-sale rules prevent taxpayers from realizing a loss for tax purposes while retaining substantially the same economic position. The loss is disallowed and effectively deferred by adding it to the basis of the replacement shares, so it is recovered on a later genuine disposal.

Question 21Direct Tax

A company changes its accounting policy and recognizes an additional provision of 100,000 in the current year. The tax law allows a deduction only when the liability is settled. What adjustment is required?

  1. Ignore the provision because accounting policy changes have no tax effect.
  2. Deduct 100,000 in computing taxable profit.
  3. Deduct 50,000 as a compromise between accounting and tax treatment.
  4. Add back 100,000 to accounting profit, with a deduction available when paid. Correct answer.

Explanation

Where tax law permits a deduction only on payment, a provision charged to the accounts must be added back in computing taxable profit. The timing difference reverses and the deduction is claimed in the period the liability is settled.

Question 22Direct Tax

A group wishes to transfer an asset with an unrealized gain between two wholly owned subsidiaries. Which condition is most characteristic of tax-neutral intra-group transfer rules?

  1. Both companies must be members of the same group at the time of transfer, and the asset must remain within the group. Correct answer.
  2. The transfer must be made at market value and the gain taxed immediately.
  3. The transfer must involve cash consideration equal to the gain.
  4. The transferee must be outside the group to avoid deferral.

Explanation

Intra-group transfer rules defer gain recognition where both parties are group members at the time of transfer and the asset stays within the group, with clawback if it later leaves. This preserves the group's overall tax position rather than triggering tax on internal reorganization.

Question 23Direct Tax

A controlled foreign company earns passive income in a low-tax jurisdiction. Under CFC rules, when is that income typically attributed to the domestic parent?

  1. Only when the CFC is listed on a stock exchange.
  2. When the parent holds a control threshold and the income is subject to tax below a specified level or falls within passive categories. Correct answer.
  3. Only when the income is distributed as a dividend.
  4. Never, because foreign companies are separate legal persons.

Explanation

CFC rules attribute certain undistributed income of controlled foreign companies to domestic shareholders where control tests and low-tax or passive-income tests are met. The purpose is to prevent deferral of tax by accumulating profits in low-taxed entities.

Question 24Direct Tax

A company has tax losses carried forward. It issues substantial new shares to outside investors, changing more than half its ownership. What is the likely effect under continuity-of-ownership rules?

  1. The losses remain fully available with no restriction.
  2. The losses convert automatically into a tax credit.
  3. The losses must be carried back to the pre-change years.
  4. The carried-forward losses may be restricted or forfeited unless a business continuity test is also satisfied. Correct answer.

Explanation

Continuity-of-ownership rules restrict carried-forward losses after a major ownership change to prevent trading in loss companies. Many systems also apply a business continuity or same-trade test, and relief is denied where both tests fail.

Question 25Direct Tax

A taxpayer uses an aggressive structure whose sole or dominant purpose is to obtain a tax advantage, and the arrangement lacks commercial substance. Under a general anti-avoidance rule, what is the typical outcome?

  1. The taxpayer is automatically subject to criminal penalties.
  2. The tax authority may disregard or recharacterize the arrangement and assess tax as if the advantage had not arisen. Correct answer.
  3. The arrangement is respected because it is legally valid.
  4. The arrangement becomes taxable only if disclosed voluntarily.

Explanation

A general anti-avoidance rule allows the tax authority to disregard or recharacterize arrangements lacking commercial substance whose main purpose is a tax advantage, and to assess the tax that would otherwise have been due. Criminal penalties are separate and require a different standard of proof.

Question 26Direct Tax

A company's taxable profit before depreciation is 400,000. Tax depreciation for the year is 90,000 while accounting depreciation charged was 60,000. What is taxable profit?

  1. 370,000 Correct answer.
  2. 400,000
  3. 430,000
  4. 460,000

Explanation

Taxable profit starts from accounting profit and is adjusted for the excess of tax depreciation over book depreciation. The excess of 30,000 (90,000 − 60,000) is deducted, giving 400,000 − 30,000 = 370,000. Depreciation itself is not deductible; only the tax allowance is.

Question 27Direct Tax

Which item is generally treated as a permanent difference rather than a temporary difference when reconciling accounting profit to taxable profit?

  1. An accrued bonus payable to employees next year
  2. A fine for late filing of a statutory return Correct answer.
  3. Unrealized gain on an investment measured at fair value
  4. A provision for warranty costs recognized before payment

Explanation

Fines and penalties are commonly non-deductible in perpetuity, so they never reverse and are permanent differences. Provisions, accruals and unrealized fair-value gains are timing items that reverse in later periods and therefore create temporary differences.

Question 28Direct Tax

A company has an assessed loss of 250,000 carried forward. In the current year it earns taxable income of 180,000 before loss relief. Assuming no restriction applies, what is taxable income after the set-off?

  1. 180,000
  2. 70,000
  3. 250,000
  4. Nil Correct answer.

Explanation

A carried-forward loss is set off against current taxable income to the extent of that income, so 180,000 of the 250,000 loss is used and taxable income becomes nil. The unused 70,000 remains available for future years subject to any ownership or continuity rules.

Question 29Direct Tax

Under a classical corporate tax system, how is dividend income ultimately taxed?

  1. Only once, at the corporate level, with the shareholder exempt
  2. Once at the corporate level and again in the shareholder's hands Correct answer.
  3. Only once, in the shareholder's hands, with the company exempt
  4. At a flat rate that replaces all other income tax on the shareholder

Explanation

A classical system imposes corporate income tax on profits and then taxes the distribution again as shareholder income, producing economic double taxation. Integration systems such as imputation or exemption relieve that double charge.

Question 30Direct Tax

An individual's taxable income falls into a bracket taxed at 25 percent, and the marginal rate on the next slice is 30 percent. What does the 30 percent rate represent?

  1. The average rate on total taxable income
  2. The rate applied to the next unit of income Correct answer.
  3. The effective rate after all credits
  4. The rate applied to the first unit of income

Explanation

A marginal rate applies to the next increment of taxable income within a progressive schedule. The average rate is total tax divided by total income and is always lower than the marginal rate in a progressive system.

Question 31Direct Tax

A resident company pays a non-resident 100,000 for technical services performed entirely outside the country, and the contract has no local-source element. Which outcome is typical under domestic source rules?

  1. Withholding applies at the standard dividend rate
  2. No domestic withholding applies because the income is foreign-sourced Correct answer.
  3. Withholding applies because the payer is resident
  4. The payment is treated as a capital distribution

Explanation

Withholding obligations on cross-border payments generally attach only where the income has a domestic source under the applicable source rules. Services physically performed abroad with no local element typically fall outside the charge.

Question 32Direct Tax

Which of the following is a characteristic of an indirect tax rather than a direct tax?

  1. It is collected through self-assessment of net profit
  2. It is levied on capital gains realized by residents
  3. The burden is intended to be passed on to the final consumer Correct answer.
  4. It is assessed on the taxpayer's annual worldwide income

Explanation

Indirect taxes such as VAT are levied on transactions and are designed to be shifted forward to consumers. Direct taxes fall on income, profits or gains of the person assessed and are not intended to be passed on.

Question 33Direct Tax

A company incurs 50,000 of entertainment expenses, of which 20,000 relates to staff canteen costs that are specifically deductible under the rules. Assuming only 50 percent of the remaining entertainment is deductible, what is the deductible amount?

  1. 45,000
  2. 25,000
  3. 20,000
  4. 35,000 Correct answer.

Explanation

The canteen costs are fully deductible at 20,000. The remaining 30,000 of entertainment is deductible at 50 percent, giving 15,000, so the total is 35,000.

Question 34Direct Tax

A company receives a government grant of 80,000 to purchase machinery costing 200,000. The grant is credited against the asset's cost for tax purposes. What is the tax depreciation base?

  1. 120,000 Correct answer.
  2. 200,000
  3. 280,000
  4. 80,000

Explanation

Where a grant is applied to reduce the capital cost of the asset for tax purposes, allowances are computed on the net cost. The base is therefore 200,000 − 80,000 = 120,000.

Question 35Direct Tax

An individual taxpayer fails to file a return by the due date and underpays tax as a result. Which combination of consequences is most typical under domestic penalty rules?

  1. Criminal prosecution only, with no civil penalty
  2. A penalty capped at the amount of tax already paid
  3. A late-filing penalty plus interest on the unpaid tax Correct answer.
  4. Automatic waiver if the return is filed within the same tax year

Explanation

Administrative penalty regimes generally impose a filing penalty calculated by reference to the tax unpaid, together with interest running from the original due date. Criminal sanctions are reserved for serious cases such as fraud and do not displace civil penalties.

Question 36Direct Tax

A resident individual receives 60,000 of foreign dividend income and pays 9,000 of foreign tax on it. Domestic tax on the gross dividend at 20 percent is 12,000. Under an ordinary credit for foreign tax, what is the domestic tax payable?

  1. 3,000 Correct answer.
  2. 12,000
  3. 9,000
  4. 21,000

Explanation

An ordinary credit reduces domestic tax by foreign tax paid, limited to the domestic tax attributable to that income. Here 12,000 − 9,000 = 3,000 is payable, with no excess credit because the foreign tax is below the domestic cap.

Question 37Direct Tax

A company disposes of a machine for 40,000. It cost 100,000 and tax allowances of 85,000 had been claimed. What is the balancing charge or allowance?

  1. No balancing adjustment arises
  2. A balancing charge of 25,000 Correct answer.
  3. A balancing charge of 15,000
  4. A balancing allowance of 25,000

Explanation

Tax written-down value is 100,000 − 85,000 = 15,000, and the disposal proceeds of 40,000 exceed it by 25,000. That excess is a balancing charge and is added to taxable income.

Question 38Direct Tax

A parent owns 100 percent of a subsidiary and receives a dividend. Under a participation exemption, which condition is most commonly required?

  1. That the parent has no other source of income
  2. That the dividend is reinvested in fixed assets within one year
  3. A minimum holding percentage and a minimum holding period Correct answer.
  4. That the subsidiary is resident in the same city as the parent

Explanation

Participation exemptions typically require a minimum shareholding, such as 5 or 10 percent, held for a minimum period, and sometimes a subject-to-tax condition. These thresholds distinguish strategic holdings from portfolio investment.

Question 39Direct Tax

A company has an opening tax loss of 500,000. During the year more than 50 percent of its shares change hands and the business is substantially altered. What is the most typical consequence?

  1. The carried-forward loss is restricted or forfeited Correct answer.
  2. The loss is converted into a tax credit
  3. The carried-forward loss is doubled
  4. The loss may be transferred to the new shareholders

Explanation

Ownership-change and continuity-of-business rules prevent loss trading by denying or restricting carried-forward losses when control changes and the business is not continued. This protects the revenue from the sale of tax attributes.

Question 40Direct Tax

An employer provides an employee with a low-interest loan of 100,000. The official benchmark rate is 5 percent and the employee pays 2 percent. What is the taxable benefit for the year?

  1. 7,000
  2. 3,000 Correct answer.
  3. 2,000
  4. 5,000

Explanation

The benefit equals the difference between interest at the benchmark rate and interest actually paid. That is 5,000 − 2,000 = 3,000 for a full year.

Question 41Direct Tax

A company makes a donation of 30,000 to an approved charity. Taxable income before the donation is 400,000. Assuming donations are deductible up to 10 percent of that income, what is the deductible amount?

  1. 30,000 Correct answer.
  2. Nil
  3. 10,000
  4. 40,000

Explanation

The cap is 10 percent of 400,000, which is 40,000. Since the donation of 30,000 is below the cap, the full amount is deductible.

Question 42Direct Tax

A company changes an accounting estimate, increasing a deductible provision by 60,000 in the current year, but the tax deduction is only available when paid. How is the item treated in the tax computation?

  1. Deduct 60,000 now with no future adjustment
  2. Treat the 60,000 as a permanent difference
  3. Deduct 30,000 now and 30,000 next year
  4. Add back 60,000 now and deduct it when paid Correct answer.

Explanation

Because the deduction follows payment rather than accrual, the provision is added back in the current computation and deducted in the year of payment. This creates a deductible temporary difference.

Question 43Direct Tax

Which anti-avoidance rule typically permits the tax authority to disregard a transaction that lacks economic substance and recharacterize it according to its true legal effect?

  1. A transfer pricing rule
  2. A general anti-avoidance rule Correct answer.
  3. A thin capitalization rule
  4. A withholding tax rule

Explanation

A general anti-avoidance rule allows the revenue to counteract arrangements whose dominant purpose is a tax benefit and which are not genuine commercial transactions. Thin capitalization, transfer pricing and withholding rules target specific issues rather than general recharacterization.

Question 44Direct Tax

A company pays 500,000 of interest to a related non-resident lender. Equity is 1,000,000 and related-party debt is 4,000,000. Under a 2:1 debt-to-equity safe harbour, what is the disallowed interest?

  1. Nil
  2. 500,000
  3. 250,000 Correct answer.
  4. 125,000

Explanation

The permitted related-party debt is twice equity, which is 2,000,000. Debt of 4,000,000 exceeds this by 2,000,000, or half the debt, so half the interest of 500,000 is disallowed, giving 250,000.

Question 45Direct Tax

A company sells goods to a foreign subsidiary at 10 percent above the price charged to unrelated customers for comparable volumes. Which transfer pricing outcome is most likely?

  1. The transaction is exempt because it is cross-border
  2. The subsidiary must withhold tax on the full purchase price
  3. The excess is treated as a capital contribution
  4. Profits are adjusted to reflect an arm's length price Correct answer.

Explanation

Transfer pricing rules require related-party transactions to be priced as they would be between independent parties. Where the price exceeds the arm's length price, the taxable profit of the seller is adjusted upward by the excess.

Question 46Direct Tax

A resident company earns branch profits in a treaty country that are taxed there at 15 percent. The treaty provides for relief by credit. Which limitation normally applies to the credit?

  1. The credit is capped at the domestic tax on that income Correct answer.
  2. The credit is available only if no treaty exists
  3. The credit is refundable in cash where it exceeds domestic tax
  4. The credit equals the foreign tax regardless of the domestic rate

Explanation

Under an ordinary credit, relief is limited to the domestic tax attributable to the foreign income, so excess foreign tax is not normally refundable. This prevents foreign tax from eroding domestic tax on other income.

Question 47Direct Tax

A company with a 31 December year-end receives a dividend from a subsidiary on 20 December, but the dividend is not recorded until the following January when the board resolves to distribute. For tax purposes, when is the dividend generally recognized?

  1. When it becomes legally receivable, in December Correct answer.
  2. When cash is received, in January
  3. When the board resolves, in January
  4. When the annual financial statements are approved

Explanation

Tax recognition generally follows the date the right to the income becomes established, which is when the dividend is legally receivable rather than when payment is received. Accounting entries made later do not shift the timing.

Question 48Direct Tax

A company claims a deduction for a payment to a foreign affiliate that has no employees, no premises and no operations, and the payment is funded by a circular flow of cash back to the payer. Which doctrine is most likely to deny the deduction?

  1. The matching principle, because income and expense fall in different years
  2. The realization principle, because no gain has been recognized
  3. The participation exemption, because the affiliate is foreign
  4. Substance over form, because the arrangement lacks commercial reality Correct answer.

Explanation

Where a payment is circular and the recipient has no economic capacity to perform, the arrangement lacks substance and the deduction is denied. The legal form of a service agreement does not override the absence of genuine commercial activity.

Question 49Direct Tax

A company operates through a foreign permanent establishment and the treaty exempts the PE's profits in the residence state. How are losses of that PE typically treated in the residence state?

  1. They may be excluded, with relief deferred until the PE becomes profitable Correct answer.
  2. They are always deductible immediately with no recapture
  3. They are converted into a refundable credit
  4. They are allocated to the parent's domestic profits without adjustment

Explanation

Where profits are exempt under a treaty, the residence state commonly excludes the PE's losses as well, or grants them with a recapture mechanism so later profits are taxed until prior losses are recovered. This preserves symmetry between exempt income and denied losses.

Question 50Direct Tax

A company disposes of shares in a subsidiary at a loss and, under the rules, the loss is ignored, while a gain on the same shares would have been exempt. What principle explains this result?

  1. The realization principle
  2. The matching of income and expenditure
  3. The arm's length principle
  4. Symmetry of treatment between exempt gains and losses Correct answer.

Explanation

Where gains on qualifying share disposals are exempt, the corresponding losses are usually disregarded so that the taxpayer cannot claim relief without being taxed on the upside. This symmetry is a deliberate design feature of participation exemption regimes.