Business Law and Practice - Income Tax

Question 1

Individuals

Answer 1

Includes sole traders, partners in business partnership, personal representatives representing estate of deceased and trustees on behalf of a trust

Question 2

Income

Answer 2

Money that comes in on an occuring or recurring basis

E.g. salary, interest on savings account, profits of a business

Question 3

Tax year

Answer 3

Runs from 6th April to following 5th April

Question 4

Collection of the Tax

Answer 4

HMRC collects tax through PAYE and self-assessment systems

• PAYE: employer retains tax from employees making more than £184 per week, submit a full payment submission (FPS) on or before each payday, money retained must be received by HMRC at least monthly - by the 22nd (along with FPS)
• Self-assessment: income from sources other than salary. Must register with HMRC within 3 months of opening and file tax returns by 31st January after tax year end (for electronic returns) and by 31st October after tax year end (for paper returns)

Question 5

When are taxes due?

Answer 5

First instalment - 31 January of tax year in question
Second instalment - 31 July after the end of the tax year
Balacing instalment - 31 January after the end of the tax year (if necessary)

Each payment on account is 50% of the previous tax year’s liability

Question 6

Categories of Income

Answer 6

1. Non-savings income
2. Savings income
3. Dividend income

Question 7

Non-savings income

Answer 7

Employment, pensions, trading income from running one’s own business and property income (e.g. rent)

Question 8

Savings income

Answer 8

Interests from bank deposits and corporate and government bonds

Income from individual savings accounts and premium bonds is tax free

Question 9

Dividend income

Answer 9

Money paid to shareholders of a company

Question 10

Calculating Trading Profit

Answer 10

Gross revenue - (revenue expenses + AIA + writing down allowance)

Revenue related expenses = recurring expenses that are wholly and exclusively incurred for business purposes such as:

• Salaries of employees
• Rent
• Advertising
• Cost of goods/services sold

‘Wholly and exclusively’ = if expense was incurred for both business and personal purposes you can deduct the proportion that is related wholly and exclusively to the business

Revenue related expenses do not include capital assets

AIA = capital items within annual investment allowance

Question 11

Capital Asset

Answer 11

An asset that is expected to last for years

Question 12

Annual Investment Allowance (AIA)

Answer 12

If asset falls into AIA the full cost of asset purchase can be deducted up to AIA amount

Costs within AIA are 100% deductable

If the asset is not within the AIA a partial deduction may be available under the Writing Down Allowance

Taxpayers given a AIA each year for plant and machinery (not available for cars, land or buildings)

AIA figure changes regularly

If full AIA not used you cannot carry it forward

Question 13

Writing Down Allowance

Answer 13

An allowance of a set percentage of capital asset acquisition costs each year

Cost of assets not within AIA are placed within one of several pools

• Main (or general) pool - 18% per annum
• Special rate pool - 6% per annum

Write down deducted from amount in the pool and what is leftover is carried over to the next year

Never available on land but commercial structures and buildings constructed since October 2018 are allowed to deduct a different allowance each year of 3% per annum on cost

Question 14

Partners

Answer 14

Subject to tax only on proportion of profits allocated to the partner (regardless of whether profits distributed or not)

This will be set out in partnership agreement or an equal split if partnership agreement is silent as to allocation of profits

Partners must nominate one partner who is responsible for filing a partnership tax return

Salaries and interest on capital accounts allocated first and amount remaining divded among the partners

Question 15

Overlap Profit

Answer 15

A business’s accounting period may be different to the tax year

Some of the profits of its first accounting period will be taxed twice - no relief from double taxation until the business ceases trade or its aligns its accounting period with the tax year

Question 16

Income Tax Formula

Answer 16

Gross income - qualifying loan interest = net income

• Qualifying loan interest = Interest on loans taken to fund capital contributions or loans to a partnership, investments in a close trading company or interest on loans taken by a personal representative to pay inheritance tax

Net income - allowances and other reliefs = taxable income

Question 17

Personal Allowance

Answer 17

Available to every individual unless the person has income in excess of £100,000

• For every £2 of income over £100,000 the personal allowance is reduced by £1 (taper)

Changes from year to year

Pay tax on income only over the personal allowance amount

Question 18

Marriage Allowance

Answer 18

Permits one spouse/civil partner to transfer part of their personal allowance to the other resulting in a credit against tax owed

Three conditions must be met:

1. Married or in a civil partnership
2. Transferor’s income less than personal allowance
3. Recipient a basic rate taxpayer (20%)

Amount that can be transferred changes with the personal allowance

Set up as a tax reduction rather than as an increase to transferee’s personal allowance

Question 19

Tax Bands

Answer 19

For savings and non-savings income

• Basic rate band
• Higher rate band
• Additional rate band

For 2021/22 the bands were:

• Basic: 20%
• Higher: 40%
• Additional rate: 45%

May need to remember these

Question 20

Savings Income

Answer 20

Tax bands and rates are the same as for non-savings income

Personal savings allowance:

• Basic Rate Taxpayer - PSA of £1,000
• Higher Rate Taxpayer - PSA of £500
• Additional Rate Taxpayer - No PSA

Interest from a bank, building society, etc

Treat the income within the band as being there but taxed at 0% (nil rate band)

• E.g. a taxpayer who has £37,700 of non-savings income (basic rate taxpayer) and £800 of savings income they are entitled to £500 PSA

Question 21

Dividend Income

Answer 21

Everyone who receives dividends entitled to a dividend allowance of £2,000 regardless of their tax bracket

Dividend allowance can be used only against dividends

£2,000 isn’t deducted from income - instead, first £2,000 of dividend income is taxed at 0%

Dividend Tax Rates:

• 7.5% for dividends that fall within taxpayer’s basic rate band
• 32.5% for dividends that fall within taxpayer’s higher rate band
• 38.1% for dividends that fall within taxpayer’s additional rate band

Rates unlikely to be tested on exam

Question 22

Trading Losses

Answer 22

The taxpayer who made the loss can claim the relief - it is not transferrable

Unless partnership agreement provides otherwise a partner’s share of the loss is the same as for profits

Question 23

Options for offsetting trade losses

Answer 23

Set loss against taxpayer’s net income from current or **prior ** tax year

• All or nothing claim - must use all of the loss

Can offset remaining loss against capital gains in same year

Carry forward against future trading profits (‘carry forward loss relief’)

Use to offset company dividends or salary upon incorporation

Terminal loss relief: allows any trade loss generated in the final 12 months of trade to be carried back to the proceeding three tax years on a last in first out basis and be deducted from trade profits

Question 24

Anti-Avoidance

Answer 24

Tax evasion: illegal

Tax avoidance: legal

Growth in anti-avoidance legislation which has lead to the General Anti-Abuse Rules (GAAR)

• Can arrangement be reasonably be regarded as a reasonable cause of action?