CAF-2 · Chapter 7
Income from Business - Part One MCQs with Answers
15 multiple-choice questions on Income from Business - Part One for CAF-2 Taxation Principles and Compliance. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Which of the following incomes is NOT chargeable to tax under the head "Income from Business"?
- A) A) Income derived from the hire or lease of tangible movable property.
- B) B) Management fee derived by a modaraba management company.
- C) C) Rent received from the sub-lease of land or a building.
- D) D) Fair market value of a benefit derived by virtue of a past business relationship.
Show answer & explanation
Answer: C) C) Rent received from the sub-lease of land or a building.
Rent from the sub-lease of land or a building is specifically chargeable to tax under the head "Income from Other Sources". The other options are expressly classified as Income from Business.
Question 2
Mr. A incurred a loss of Rs. 500,000 in a speculation business during the tax year. How can this loss be treated under the Income Tax Ordinance, 2001?
- A) A) It can be set off against his normal trading business income in the same year.
- B) B) It can be set off against any head of income.
- C) C) It can only be set off against income from another speculation business and can be carried forward up to six tax years.
- D) D) It cannot be carried forward to the next tax year under any circumstances.
Show answer & explanation
Answer: C) C) It can only be set off against income from another speculation business and can be carried forward up to six tax years.
A speculation business is treated as distinct and separate. Any loss from it can only be set off against income from another speculation business and can be carried forward up to six immediately succeeding tax years.
Question 3
XYZ Limited entered into a forward contract for the purchase of raw materials used in its manufacturing business to guard against loss through future price fluctuations. On maturity, the contract was settled by a cash payment without taking actual delivery of the raw materials. How is this transaction classified for tax purposes?
- A) A) It is treated as a speculation business because no actual delivery took place.
- B) B) It is treated as capital gains.
- C) C) It is excluded from the definition of a speculation business because it is a hedging contract for manufacturing.
- D) D) It is treated as income from other sources.
Show answer & explanation
Answer: C) C) It is excluded from the definition of a speculation business because it is a hedging contract for manufacturing.
A contract in respect of raw materials entered into by a person in the course of a manufacturing business to guard against loss through future price fluctuations (hedging) is specifically excluded from the definition of "speculation business".
Question 4
An employer paid a monthly salary of Rs. 35,000 to an employee in cash. How will this be treated when calculating the employer's taxable business income?
- A) A) Fully allowed as an admissible business deduction.
- B) B) Disallowed because any salary exceeding Rs. 32,000 per month must be paid via crossed cheque or direct bank transfer.
- C) C) Disallowed because cash payments are only allowed up to Rs. 25,000.
- D) D) Allowed up to Rs. 32,000, and the remaining Rs. 3,000 is disallowed.
Show answer & explanation
Answer: B) B) Disallowed because any salary exceeding Rs. 32,000 per month must be paid via crossed cheque or direct bank transfer.
Under Section 21, any salary paid or payable exceeding Rs. 32,000 per month is an inadmissible deduction if it is paid otherwise than by a crossed cheque or direct transfer of funds to the employee’s bank account.
Question 5
Under Section 21, any expenditure paid under a single account head exceeding Rs. 250,000 made in cash (otherwise than through a banking channel) is disallowed. Which of the following cash payments exceeding Rs. 250,000 is an EXCEPTION and still ALLOWED as a deduction?
- A) A) Payment for raw material purchases.
- B) B) Payment for office rent.
- C) C) Payment for utility bills and freight charges.
- D) D) Payment for a marketing and advertising campaign.
Show answer & explanation
Answer: C) C) Payment for utility bills and freight charges.
The restriction of Rs. 250,000 for cash payments does not apply to expenditures on account of utility bills, freight charges, travel fare, postage, and the payment of taxes, duties, or fines.
Question 6
Which of the following payments made by an Association of Persons (AOP) to one of its members is an admissible deduction when computing the AOP's income from business?
- A) A) Salary paid to the member for managing the business.
- B) B) Commission paid to the member for securing a contract.
- C) C) Profit on debt paid to the member.
- D) D) None of the above.
Show answer & explanation
Answer: D) D) None of the above.
Under Section 21, any profit on debt, brokerage, commission, salary, or other remuneration paid by an Association of Persons (AOP) to a member of the association is strictly an inadmissible deduction.
Question 7
ABC Ltd made a sale of Rs. 500,000 and the corresponding expense for this specific transaction was Rs. 300,000. The customer paid Rs. 250,000 in cash against this single invoice. What is the tax implication under the Income Tax Ordinance, 2001?
- A) A) The entire sale of Rs. 500,000 is exempt from tax.
- B) B) 50% of the corresponding expenditure (Rs. 150,000) shall be disallowed.
- C) C) The entire expense of Rs. 300,000 shall be disallowed.
- D) D) No disallowance occurs because the cash receipt is less than the total invoice value.
Show answer & explanation
Answer: B) B) 50% of the corresponding expenditure (Rs. 150,000) shall be disallowed.
Where a taxpayer receives a payment exceeding Rs. 200,000 otherwise than through a banking channel against a single invoice, 50% of the corresponding expenditure shall be disallowed. Since the cash receipt was Rs. 250,000, 50% of the Rs. 300,000 expense (Rs. 150,000) is disallowed.
Question 8
To successfully claim a deduction for a bad debt under Section 29, which of the following conditions MUST be satisfied?
- A) A) The debt must have been previously included in the person's income from business chargeable to tax.
- B) B) The debt must be written off in the accounts for the tax year.
- C) C) There must be reasonable grounds to believe the debt is irrecoverable.
- D) D) All of the above.
Show answer & explanation
Answer: D) D) All of the above.
For a bad debt to be allowable, it must have been previously included in taxable income (or lent by a financial institution), written off in the accounts, and there must be reasonable grounds to believe it is irrecoverable.
Question 9
In tax year 2025, an entity claimed a bad debt of Rs. 100,000, but the Commissioner allowed only Rs. 75,000 as a deduction. In tax year 2026, the entity recovered Rs. 90,000 from that specific debtor. What amount will be treated as business income for tax year 2026?
- A) A) Rs. 90,000
- B) B) Rs. 65,000
- C) C) Rs. 10,000
- D) D) Rs. 75,000
Show answer & explanation
Answer: B) B) Rs. 65,000
The formula is (a - b), where 'a' is the amount received (Rs. 90,000) and 'b' is the difference between the whole bad debt and the amount allowed (100,000 - 75,000 = 25,000). Since 90,000 is greater than 25,000, the difference (90,000 - 25,000 = Rs. 65,000) is treated as income.
Question 10
Which method of accounting MUST a company follow for computing income chargeable under the head "Income from Business"?
- A) A) Cash basis only
- B) B) Accrual basis only
- C) C) Either cash or accrual basis, at the company's discretion
- D) D) The hybrid method
Show answer & explanation
Answer: B) B) Accrual basis only
According to Section 32, a company shall account for income chargeable to tax under the head "Income from Business" strictly on an accrual basis, while other persons (like individuals or AOPs) may use cash or accrual.
Question 11
A person accounting for business income on a cash basis may compute the cost of stock-in-trade using either the prime-cost or absorption-cost method. What method MUST a person accounting on an accrual basis use?
- A) A) Prime-cost method
- B) B) Absorption-cost method
- C) C) Marginal-cost method
- D) D) Standard-cost method
Show answer & explanation
Answer: B) B) Absorption-cost method
Section 35 dictates that a person accounting for income on an accrual basis MUST compute the cost of stock-in-trade using the absorption-cost method (which includes direct materials, direct labor, and all factory overheads).
Question 12
Where particular items of stock-in-trade are not readily identifiable, the Income Tax Ordinance allows the use of specific inventory valuation methods. Which of the following methods is NOT permitted for tax purposes?
- A) A) First-In-First-Out (FIFO) method
- B) B) Average-cost method
- C) C) Last-In-First-Out (LIFO) method
- D) D) Both A and B
Show answer & explanation
Answer: C) C) Last-In-First-Out (LIFO) method
A person may account for stock on the First-in-First-out (FIFO) method or the Average-cost method. The Last-In-First-Out (LIFO) method is not permitted under the Income Tax Ordinance, 2001.
Question 13
The closing value of a person's stock-in-trade for a tax year shall be determined as:
- A) A) The higher of cost or fair market value.
- B) B) The lower of cost or net realizable value (NRV).
- C) C) The standard cost determined by the Federal Board of Revenue.
- D) D) The historical cost without any adjustments.
Show answer & explanation
Answer: B) B) The lower of cost or net realizable value (NRV).
Section 35 clearly states that the closing value of a person's stock-in-trade for a tax year shall be the lower of cost or net realizable value (NRV) of the stock on hand at the end of the year.
Question 14
Under the taxation of digital transactions within Pakistan, what is the rate of the final sales tax withholding required to be collected by a courier service on digitally ordered goods paid via Cash on Delivery (CoD)?
- A) A) 1%
- B) B) 2%
- C) C) 5%
- D) D) 18%
Show answer & explanation
Answer: B) B) 2%
A tax has been introduced at the rate of 1% (for digital/banking channels) and 2% (for Cash on Delivery by courier services) of the gross amount on persons receiving payment for digitally ordered goods delivered from within Pakistan.
Question 15
ABC Ltd paid Rs. 45,000 as a penalty to the Commissioner for the late filing of its annual return of income. How will this be treated when calculating Income from Business?
- A) A) It is fully allowed as a normal business expense.
- B) B) It is allowed up to 50% of the penalty amount.
- C) C) It is an inadmissible deduction.
- D) D) It is allowed only if the company is listed on a stock exchange.
Show answer & explanation
Answer: C) C) It is an inadmissible deduction.
Under Section 21, any fine or penalty paid or payable by the person for the violation of any law, rule, or regulation is strictly an inadmissible deduction.