The only legal formula for calculating the taxable profit is the change in the net assets from one balance sheet to the next, plus any personal withdrawals made during the financial year and minus any additional contributions made during the financial year. In practice, however, the tax authorities think in terms of income and expenditure, because all income is found on the asset side of the balance sheet and all expenditure on the liability side.

The operating result is the difference between the operating income (sales and services) and the operating expenses (cost of sales and services). If the difference is positive (negative), the business makes an operating profit (loss).

The operating expenses and income relate to the usual business and industrial activities of the business.

Operating income

Turnover

Turnover refers to the amount of goods and services sold to third parties as part of the normal business activity of the business, after the deduction of trade discounts on sales (reductions, discounts and rebates). This income is taxable.

Regime for the sale of goods

Sales are attributed to the year in which they were carried out. Acquired receivables where the principle and amount is definite, even if they have not yet been settled, are therefore taken into account.

The (physical) delivery date of goods is used to enter the receivables in the seller's accounts.

Regime for the provision of services

The services are attributed to the financial year in which they were provided. A distinction must be made between:

• immediate provision of services: these are taken into account when the service has been fully provided, unless the invoice is only issued later. In this case the receivable will be recognised in the accounts at the invoice date (example: provision of a lawyer’s services in the form of a legal opinion);
• ongoing services: they may take the form of:
  • continuous remuneration (interest, rental payment, etc.), in which case the receivable will be recorded on a pro rata temporis basis, even if the date on which the income is posted on the debtor’s books (example: bank account statement) is much later;
  • services provided at regular intervals over several financial years (example: maintenance contract for computer equipment, with maintenance performed every 6 months). These services are also recorded on a pro rata temporis basis and not on the date on which the services were actually provided.

• contract work carried out over a long period (example: building construction):
  The date used to record income is the date of:
  • final acceptance or delivery of the works if prior to acceptance;
  • partial acceptance if this takes place before final acceptance or delivery.
• work in progress: works which, at financial year-end, have been carried out at the request of customers but have not yet been invoiced to them. When delivery or the provision of services has not yet occurred or ended on this date, they are not included in the calculation of the accounting result. However, works in progress have already incurred costs for the business. For this reason the works in progress must be included on the balance sheet at cost price in order to avoid distorting the financial statements of several successive financial years. However, the bookkeeping and taxation of the margin realised by the business will be carried forward to the date on which the works are completed.

Composition and valuation of stock

The stock comprises all the goods and raw materials belonging to the business and intended for sale or for use in the operating cycle.

The stock must be valued at the end of the accounting year in order to compare their purchase cost to their market value, also referred to as the “rate of the day”. There are 2 possible scenarios:

• either the market value of the stock exceeds the purchase cost. The unrealised gain relating thereto is therefore ignored;
• or the market value on the inventory date is lower than the purchase cost or cost price. The business can then set up a provision for depreciation called a 'value adjustment' in order to fix the value of stock on the year-end date, where the rate of the day is the price at which the goods could be sold on the market on the inventory date. This value adjustment is provisional and will be reversed when the products are sold.

The stock is valued on the basis of either the purchase cost (trading company) or the cost price (industrial company), depending on the case.

If each item in stock cannot be individualised, since the goods in stock are fungible (goods that are identical in nature, quality and value), the valuation rules applicable are those relating to fungible goods and so the taxpayer has a choice of 3 methods.

Sundry income

Sundry income is income which, despite being of a recurring nature, is not generated directly by the normal activities of the business. It nevertheless forms part of the taxable result. In practice the 3 main headings are real estate income, tax income and financial income.

Rental income

When buildings are recorded as assets of a business, the income arising therefrom is taxable as income of the business. This income is calculated on a pro rata temporis basis. On the other hand, the depreciation, interest on loans and property tax relating thereto are deductible from the commercial profit.

Tax income

Tax income is generated when a business pays more tax than the amount actually due, generally as a result of a calculation error. This type of income is not taxable. Paid taxes are not deductible as expenses.

Financial income (interest and dividends)

Interest on receivables or bonds: the taxable amount is the amount of interest accrued over the year;

Dividends: dividends must be recorded on the date decided upon during the the meeting where they were granted. The taxation of dividends received varies depending on the type of company that distributes them:

Operating expenses

The operating expenses or business costs are those resulting directly from the ordinary activities of the business.

General conditions for the deduction of expenses

An expense is only deductible from income if it reduced the assets of the business. There must also be a direct economic link between the expenses incurred and the commercial activities of the taxpayer.

Note that the tax authorities are not asked to judge whether an expense is appropriate. But exclusion may occur if the expense has nothing to do with the business activity.

Exclusion of personal expenditure

The taxpayer’s day-to-day expenses are not deductible, even if they could benefit the business.

Some expenses are both professional and private in nature: such mixed expenses are generally considered to be private expenses and are usually non-deductible. Partial deduction is possible, however, where the professional and private parts can be clearly separated according to objective and traceable criteria.

Exclusion of expenses that do not reduce the assets of the business

There must be a reduction in the assets and not simply a change in their composition. Similarly, the conversion of assets from one form to another form does not constitute an expense.

Expenses for improvements or investment are classed as fixed assets and are therefore non-deductible expenses. However, maintenance expenses are deductible.

In practice, the distinction between maintenance and investment expenses is based on 3 criteria, proof of just one of which is sufficient to make the expense a fixed asset; if there is any doubt the expense will be deemed to be a maintenance expense. An expense is therefore a fixed asset if:

• it involves an increase in the basic substance of the building (example: extension of the available living space of a building);
• it involves a change in the characteristics of the building, i.e. change in allocation or use of the building (example: transforming a garage into a workshop);
• it substantially improves the previous condition of the building in a way that gives rise to a new economic asset.

Exclusion of expenses with an economic link to exempt income

Where income is not taxable, the corresponding expenditure is not deductible. 

The 50% exemption of dividends implies the non-deductibility of half of the expenses directly related with said revenue as for example financing expenses or foreign personal taxes.

Purchases

Not all expenses incurred by a business are necessarily deductible: some of them reduce the assets of the business while others do not. Expenses that reduce the assets are called operating expenses; those that do not reduce the assets are called investment expenses.

Criteria

The criteria for comparing deductible expenses to fixed assets and stock are as follows:

• deductible expenses are all expenses that reduce the invested net assets of the business (asset value), with no offsetting gain;
• fixed assets and stock are expenses that involve the introduction of a substitute asset into the assets of the business.

Overheads

Overheads are general expenses incurred by a business that have no offsetting gain and therefore result in a reduction in the net assets.

Only overheads associated with the current financial year are deductible. Overheads follow the general method of full accrual basis accounting. Therefore, in financial year N, the business cannot deduct overheads relating to the financial year N+1 and subsequent years. However, it is possible to spread over several financial years the expenses paid during a particular year but which relate economically to several years.

There is no particular formal requirement to ensure deduction. It suffices for the expenses to be entered correctly in the accounts, keeping receipts available for the tax authorities in case they should ask for them.

Depreciation

Definition

Depreciation is a deduction from the profits to compensate for the depreciation of assets that show signs of wear over time. It involves the recording of this depreciation in the accounts and should enable the asset to be replaced at the end of its estimated useful life.

Assets that can be depreciated

Depreciation applies to fixed assets (stock is not depreciated) that depreciate: buildings, machinery, vehicles, etc. Land cannot be depreciated as it does not depreciate in value (except quarries). Depreciation applies to tangible assets (machinery, etc.) as well as intangible assets (goodwill, patents, etc.). Start-up costs constitute a specific case of assets that may be depreciated. They are extraordinary expenses (notary fees, capital duty) incurred by the creation or enlargement of the business that do not result in the entry of any items on the balance sheet of the business. These costs can be depreciated over a period of one to 5 years at the discretion of the taxpayer.

Only assets that the business legally owns can be depreciated (therefore excluding leased assets, except for certain forms of leasing).

Basis for depreciation

Depreciation is applied to either the purchase cost of the asset or the cost price if the fixed asset was created by the business itself. VAT on the asset can only be depreciated if it cannot be recovered by the business.

Depreciation period

It is not laid down by law but by the business in accordance with the common practice of each industry, trade or operation (industrial building: 20 years; office furniture: 10 years; vehicles: 4 years, etc.).

Bookkeeping

The annual depreciation amount (charge) must be entered in the accounts or it may be lost (depreciation cannot be deferred). In principle the depreciation is calculated as of the purchase or entry into service of the asset. To simplify matters, the depreciation may be calculated as of the start of the year of acquisition if the asset is bought during the first half of ^the year. The annual depreciation charge will be for half a year if the asset is acquired during the second half of ^the year.

Depreciation methods

The annual depreciation charge is calculated using one of the two following methods:

• straight-line depreciation is where depreciation is spread equally over the entire useful life of the asset. Straight-line depreciation is a system of constant annual depreciation charges, where the business records the same depreciation amount each year in its books (example: purchase cost 100, useful life 4 years => annual depreciation charge = 100 / 4 = 25).

Straight-line depreciation must be used for assets that, due to their nature, cannot benefit from the reducing balance depreciation method. It may be opted for in the case of assets that can benefit from the reducing balance depreciation method.

• reducing balance depreciation is a depreciation method that has high annual depreciation charges at the start of the period of use of the asset and which gradually decrease over the period of use. Reducing balance depreciation is allowed but not compulsory. Reducing balance depreciation is used for tangible assets other than buildings (intangible assets are therefore excluded). In addition, the tangible assets must be used by the owner (tangible assets that are rented out are therefore excluded).

*Reducing balance depreciation rates are capped: triple the straight-line rate or 30 %, whichever is lower (quadruple the straight-line rate or 40 %, whichever is lower, for equipment and tools used exclusively for scientific or technical research operations). 

When the reducing balance annual depreciation charge falls below the straight-line annual depreciation charge calculated on the basis of the number of years outstanding, the business can change over to the straight-line method.

Provisions

Provisions are deductions made from the profits to deal with losses associated with asset items (value adjustments) or expenses (provisions for liabilities and charges) that are not yet definite but probable (probability of future impoverishment caused by an event during the current financial year => hence the need to provide for them): irrecoverable debt, essential repairs, ongoing litigation, etc.

Deductions for provisions are subject to 2 conditions:

• the deduction must concern a loss or expense that, if it had been definite, would have been deductible as a loss or expense (example: the cost of repairs is deductible, so a provision for repairs is also deductible; income tax is not deductible so a provision for income tax is not deductible either);
• the loss or expense must be genuinely probable and not just possible (note: a simple foreseeable loss of earnings, such as a drop in the market, cannot be covered by a provision).

There are no special formalities for the deduction of the provision. However, proof of the genuine nature of the provision must be provided to the tax authorities by any suitable means.

Value adjustments

Assets concerned: value adjustments are possible for all assets held by the business: fixed and current assets, depreciable and non-depreciable assets (examples: provision for the depreciation of stock if the rate is below the purchase cost; provision for the depreciation of securities if the stock market price of bonds falls below the cost of buying the securities; etc.).

Reversal of a value adjustment: a value adjustment that is no longer justified can in principle be maintained, as long as the asset covered by the provision is not removed from the balance sheet of the business (example: collection of the receivable). However, value adjustments for participating interests must be reversed if the cause of the value adjustment disappears.

Scope of deduction: if the loss or expense materialises, the deduction is definitive. If it does not materialise, the provision is reinstated in the profit.

Provisions for liabilities and charges

Liabilities and charges concerned: only expenses that represent overheads. It is not possible to make a provision for the renewal of equipment because when the expense is incurred the business will have the use of additional capital goods. There will not have been any reduction in the business assets.

Distinction between financial years: provisions must be attached economically to the accounting year that has just ended and not anticipate future expenses attached to future financial years. This is why a provision for litigation is deductible in year N if the cause of this foreseeable litigation in N+1 is the result of the sale of faulty goods in year N. However, it is not possible to make a provision in year N for roof maintenance works that will most likely be carried out in N+1 if no event (storm, defect noticed in the roof) justifying the provision has occurred in year N.