Business tax chapter 2 Flashcards
Name the badges of trade
1) Subject Matter
2) Frequency of transactions
3) Length of ownership
4) Improvement expenditure
5) Profit motive
6) Reason for sale
What do the badges of trade do?
They help HMRC ascertain whether an individual is trading or not - they are tests which indicate whether trade profits have been made which are taxable under the regular business taxes of income tax or corporation tax, or if they can taxed at the lower rates of capital gains tax.
What are the adjustments that can be made to the net profits of our accounts to reach our taxable trading profits?
We start with our net profits per the accounts.
We add back any disallowable expenditure or any trade income not included in the accounts.
We deduct income not taxed as trade and any capital allowances.
Describe the specifically disallowed expenditure items (I don’t need to be able to say them all Mum, I just need to be able to tell you about each if you read the bit before the dash.
Capital expenditure - this is disallowed, but relief may be offered in the form of capital allowances later in your calculations
Depreciation - this is disallowed because the rate is chosen by the company, but relief may be offered in the form of capital allowances later in your calculations
Profit or loss on disposal of non-current assets - the profit or loss is calculated by referring to the net book value which is affected by depreciation rate, so this is also disallowed. The disposal is reflected within the capital allowance calculation
Provisions and allowances - General allowances and provisions are not allowable deductions, however specific provision adjustments are allowable.
Private expenditure - if a sole trader takes goods for his own use out of the business then these goods need to be accounted for at their normal selling price.
Wages and salaries - owners wages are technically drawings and are not considered an allowable deduction. The wages of family members are only allowable if they are reasonable (i.e. not £60,000 pa for part time labour). The wages of all other employees are allowable deductions.
Other disallowed expenditure -
1) Donations to political parties
2) Donations to charities, except small local charities that have an advertising element
3) Class 2 and Class 4 National Insurance for the business owner
4) Customer entertaining (staff entertaining is allowable)
5) Gifts to customers are disallowable, unless they are less than £50 in value, have a prominent business advertisement and are not tobacco, drinks, food or vouchers.
6) Lease cars - if a car has CO2 emissions of more than 110g/km then 15% of the lease cost is disallowable, leaving 85% allowable. If the lease car has CO2 emissions of less than 110g/km then the cost is fully deductable.
7) any law breaking fines are disallowed, however parking fines for employee’s car whilst on employer business are usually allowed. Owners parking are not usually allowed.
Legal expenses - expenses relating to capital items are not allowable but legal expenses in relation to operations such as short-term lease renewal, debt collection and employee contracts are allowable.
The overhanging theme is whether the expenses is “wholly and exclusively” for the purpose of the trade. Any expenses that fail this remoteness test are disallowed.
Disallowed expenses from the reference material
See section 3.2 - disallowed expenses in the Reference Material
Starting 6 April 2017, sole traders that earn a gross trading income that is less than £1,000 do not need to report this income or register for self-assessment. If their gross trading income is £1,350 and their total expenses are £450, what are their options?
They can calculate their trading profits in the normal way - £1,350 - £450 = £900.
Alternatively they can choose partial relief because they have annual trading income in excess of £1,000 to reduce their trading profit by £1,000, from £1,350 to £350. Obviously the second option would be more tax efficient.
