Calculating Profit and paying Vat

Question 1

What are the two kinds of profits businesses can make, and how are they taxed?

Answer 1

Businesses generate two types of profits:
1. Income Profits
* Nature: Recurring (e.g., trading profits, rent).
* Taxation:
* For sole traders/partnerships: Included in total income and taxed under income tax.
* For companies: Taxed under corporation tax.
2. Capital Profits
* Nature: One-off (e.g., profit from the sale of a building).
* Taxation:
* For companies: Also subject to corporation tax.
* Key Difference: Capital profits stem from assets used in the trade, not items purchased to sell.

Question 2

How are trading profits calculated for taxation purposes?

Answer 2

Formula:
Chargeable Receipts - Deductible Expenditure - Capital Allowances = Trading Profit/Loss
1. Chargeable Receipts:
* Money earned from goods or services.
* Must derive from trade (recurring in nature).
* Capital receipts (e.g., sale of office premises) are excluded.
2. Deductible Expenditure:
* Expenses must be incurred wholly and exclusively for the trade.
3. Capital Allowances:
* Deductions for qualifying capital items (e.g., machinery).

Question 3

What are chargeable receipts, and how is trade defined?

Answer 3

• Chargeable Receipts:
  
  • Income from the sale of goods/services.
  • Must be income in nature (recurring) and arise from the trade.
  • Definition of Trade:
  • No universal definition, but case law suggests:
  • “Operations of a commercial character providing goods/services for reward.”

Question 4

What qualifies as deductible expenditure?

Answer 4

1. Must be wholly and exclusively incurred for the trade.
   
   2. Must be income in nature:
      * Recurring expenses (e.g., stock, utilities).
      * Expenditure for selling items at a profit qualifies as income in nature.
   3. Statutory Exclusions:
      * Client entertainment.
      * High-emission car leases.
   4. Examples of Deductible Expenses:
      * Salaries (reasonable amounts).
      * Rent on commercial premises.
      * Contributions to approved pension schemes.
      * Utility bills.
      * Stock and inventory.
      * Interest on loans.

Question 5

What are capital allowances, and what qualifies as plant and machinery?

Answer 5

1. Capital Allowances:
   
   • Provided for non-deductible capital items (e.g., machinery).
   • Reduces taxable income.
   • Types:
   • Writing Down Allowance (WDA): Deducts 18% annually on pooled assets.
   • Annual Investment Allowance (AIA): Full deduction for qualifying purchases up to £1,000,000 in an accounting period.
   • Full Expensing: For new items; uncapped deduction.
     2. Plant and Machinery:
   • Equipment used for business operations (e.g., tools, computers).
   • Excludes: Stock in trade.
   • Depreciation: Reduced asset value over time, reflected in WDA.

Question 6

What loss reliefs are available for unincorporated businesses?

Answer 6

1. Start-up Loss Relief:
   
   • Loss in first 4 tax years can offset total income from 3 preceding years.
     2. Carry-back Relief:
   • Offset losses against total income from the preceding tax year.
     3. Set-off Against Capital Gains:
   • Unabsorbed losses can reduce taxable capital gains.
     4. Carry-forward Relief:
   • Losses carried forward indefinitely until profits arise.
     5. Terminal Loss Relief:
   • Final 12 months of trade: Offset against profits from the preceding 3 years.

Question 7

How does VAT operate in the UK?

Answer 7

1. Rates:
   
   • Standard rate: 20%.
   • Zero-rated items: Books, certain food, water.
   • Exempt supplies: Education, health services.
     2. Tax Mechanism:
   • Businesses collect output tax from customers and deduct input tax paid.
   • Net VAT is paid to HMRC, or a rebate is received if input tax exceeds output tax.
     3. Registration Threshold:
   • £85,000 taxable supplies in 12 months.
   • Voluntary registration allows input tax reclamation.

Question 8

What are the VAT registration and compliance requirements?

Answer 8

1. Who Registers:
   
   • Businesses with taxable supplies over £85,000 must register.
   • Partnerships can register under the partnership name.
     2. Invoices:
   • Must include VAT number, supply value, and VAT charged.
     3. Compliance Deadlines:
   • Submit VAT returns quarterly, with payment due within one month.
   • Penalties for late submission include interest, fines, and potential legal consequences.
     4. Zero-rated vs. Exempt Supplies:
   • Zero-rated: No VAT charged, but input tax reclaimable.
   • Exempt: No VAT charged, but input tax not reclaimable.

Question 9

What is the difference between full expensing and the AIA?

Answer 9

1. Full Expensing:
   * Deduct 100% of the cost of plant/machinery in the accounting period (uncapped).
   * Disposal results in balancing charge equal to 100% of sale value.
   * Applicable to new items only.
   * Applies only to companies
2. AIA:
   * Deducts up to £1,000,000 for plant/machinery purchases.
   * Includes second-hand and refurbished items.
   * Companies can choose either based on their needs.

Question 10

What reliefs apply to terminal trading losses and business incorporation?

Answer 10

1. Terminal Loss Relief:
   
   • Loss in final 12 months of trading offsets profits from the preceding 3 years.
   • Limited to trading income only.
     2. Incorporation Loss Relief:
   • Losses carried forward can offset income from shares, salary, or dividends received from the new company.
   • Requires at least 80% of the consideration for business transfer to be in company shares.

Question 11

How are capital allowances applied in trading profits, using the example of Queensbury Limited?

Answer 11

1. Initial Purchase:
   
   • Machinery purchased for £100,000.
   • No other machinery owned, and Annual Investment Allowance (AIA) is ignored.
   2. Yearly Writing Down Allowance (WDA):
      * Year 1:
      * WDA = 18% of £100,000 = £18,000.
      * Written-down value = £100,000 - £18,000 = £82,000.
      * Trading profit = £500,000 - £18,000 = £482,000.
      * Year 2:
      * WDA = 18% of £82,000 = £14,760.
      * Written-down value = £82,000 - £14,760 = £67,240.
      * Trading profit = £500,000 - £14,760 = £485,240.
      * Year 3:
      * WDA = 18% of £67,240 = £12,104.
      * Written-down value = £67,240 - £12,104 = £55,136.
      * Trading profit = £500,000 - £12,104 = £487,896.
   3. Impact of WDA:
      * Reduces taxable profits over several years.
      * Effectively spreads the deduction of the machinery cost over its useful life.
      * Allows businesses to minimize tax impact in the years following the purchase.

Question 12

What are the key differences between Full Expensing and the Annual Investment Allowance (AIA)?

Answer 12

1. Full Expensing:
   
   • Eligible Businesses: Companies only.
   • Allowance Amount: 100% allowance, uncapped.
   • Condition of Assets: Applies to brand-new assets only.
     2. Annual Investment Allowance (AIA):
   • Eligible Businesses: Both companies and unincorporated businesses.
   • Allowance Amount: 100% allowance, capped at £1 million.
   • Condition of Assets: Covers new, second-hand, and refurbished assets.

Key Distinction:
* Full Expensing provides unlimited tax relief for new assets but is restricted to companies.
* AIA offers flexibility for asset conditions and applies to a wider range of businesses but has a cap of £1 million.

Question 13

How are capital allowances calculated when the cost of plant and machinery is less than the Annual Investment Allowance (AIA)?

Answer 13

1. Scenario:
   
   • Queensbury has a machinery pool with a written-down value of £200,000.
   • Purchases second-hand machinery for £150,000.
     2. Capital Allowances Calculation:
   • AIA:
   • Entire cost of the second-hand machinery (£150,000) is fully deductible under AIA.
   • WDA:
   • Written-down value of the pool: £200,000.
   • WDA at 18%: £36,000.
     3. Total Capital Allowances:
   • AIA (£150,000) + WDA (£36,000) = £186,000.
     4. Impact:
   • £186,000 is deducted from chargeable receipts to calculate taxable profit.

Question 14

How are capital allowances calculated when the cost of plant and machinery exceeds the Annual Investment Allowance (AIA)?

Answer 14

1. Scenario:
   * Queensbury purchases machinery costing £1.2 million.
   * AIA limit: £1,000,000.
   * Excess cost of machinery: £200,000.
   * Existing pool written-down value: £200,000.
2. Capital Allowances Calculation:
   * AIA:
   * Covers the first £1,000,000 of the machinery cost.
   * WDA (18%):
   * On remaining machinery value (£200,000) + pool (£200,000) = £400,000.
   * WDA = 18% × £400,000 = £72,000.
3. Total Capital Allowances:
   * AIA (£1,000,000) + WDA (£72,000) = £1,072,000.
4. Impact:
   * Queensbury deducts £1,072,000 from chargeable receipts to calculate taxable profit.

Question 15

How are capital allowances calculated when full expensing applies?

Answer 15

1. Scenario:
   
   • Queensbury purchases brand-new machinery costing £1.2 million.
   • Existing machinery pool has a written-down value of £200,000.
     2. Capital Allowances Calculation:
   • Full Expensing:
   • 100% of the cost of the new machinery: £1,200,000.
   • WDA:
   • 18% of the written-down value of the existing pool (£200,000): £36,000.
     3. Total Capital Allowances:
   • Full Expensing (£1,200,000) + WDA (£36,000) = £1,236,000.
     4. Impact:
   • Queensbury deducts £1,236,000 from chargeable receipts to calculate taxable profit, maximizing tax relief in the accounting period.

Question 16

What is start-up loss relief, and how does it work?

Answer 16

1. Definition:
   
   • This relief allows a taxpayer who suffers a trading loss in the first four tax years of a new business to offset that loss against total income from the three preceding tax years.
     2. Mechanism:
   • Losses must first be applied to earlier tax years before later ones.
   • For example:
   • If a taxpayer incurs a loss in 2023/24, the loss can offset income from 2020/21, 2021/22, and 2022/23, starting with 2020/21.
     3. Advantages:
   • Taxpayers can reclaim income tax paid in prior employment or other businesses.
   • Particularly beneficial for higher-rate taxpayers, as they may recover taxes paid at the higher rate.
     4. Deadlines and Compliance:
   • A claim for this relief must be submitted by 31 January of the year following the tax year of the loss.
     5. Limitations:
   • Losses must offset total income, potentially reducing taxable income to £0 and resulting in the loss of the personal allowance (currently £12,570).

Question 17

How does carry-across and one-year carry-back relief for trading losses work?

Answer 17

1. Definition:
   
   • Trading losses in a tax year can be offset against total income from the same year or carried back to offset income from the previous year.
     2. Options for Relief:
   • Option 1: Apply losses to total income in the same year.
   • Option 2: Apply losses to total income in the preceding year.
   • Option 3: Apply losses to total income in the same year first (until it reaches zero), and then offset the remaining loss against the preceding year.
   • Option 4: Apply losses to total income in the preceding year first, and then offset the remaining loss against the same year.
     3. Impact:
   • Losses must offset total income, potentially reducing income to £0 and resulting in the loss of the personal allowance.
     4. Deadline:
   • Claims must be made by 31 January of the year following the tax year in which the loss was incurred.
     5. Temporary Measure (COVID-19):
   • A temporary measure during the pandemic allowed losses to be carried back for three years rather than one. This measure has now ended.

Question 18

What is the set-off against capital gains relief for trading losses?

Answer 18

1. Definition:
   
   • Trading losses that cannot be fully absorbed by income (e.g., after using carry-across relief) can be offset against chargeable capital gains in the same tax year.
     2. Mechanism:
   • The unabsorbed portion of the trading loss reduces taxable capital gains in the same year.
     3. Eligibility:
   • This relief is available only when there are unabsorbed losses after claiming carry-across relief.
     4. Advantages:
   • Allows taxpayers to reduce their liability on capital gains tax (CGT) in addition to income tax relief.
     5. Deadline:
   • Claims must be made by 31 January of the year following the tax year of the loss.
     6. Uniqueness:
   • Unlike other trading loss reliefs, this applies to both income and capital gains, making it versatile.

Question 19

What is carry-forward relief, and how does it benefit taxpayers

Answer 19

1. Definition:
   
   • Trading losses can be carried forward indefinitely to offset future profits from the same trade.
     2. Mechanism:
   • Losses offset profits from the same trade in the earliest available year.
   • Losses can be used until fully absorbed, regardless of the time it takes for the trade to become profitable.
     3. Advantages:
   • Retains the personal allowance since the loss offsets only future profits, not total income.
   • Helps taxpayers avoid higher tax bands in future profitable years.
     4. Compliance Requirements:
   • Taxpayers must notify HMRC of their intention to claim carry-forward relief.
   • Deadline: Notify HMRC no later than four years after the end of the tax year in which the loss was incurred.
     5. Disadvantages:
   • Offers no immediate tax benefit if the trade does not become profitable in future years.

Question 20

Can a taxpayer use multiple loss reliefs for the same trading loss?

Answer 20

1. Yes, a taxpayer can combine:
   
   • Carry-Across Relief: Offset losses against income from the current or preceding tax year.
   • Carry-Back Relief: Offset losses against income from earlier tax years, including start-up loss relief.
   • Carry-Forward Relief: Offset remaining losses against profits from the same trade in future years.
     2. Key Rules:
   • Reliefs are applied sequentially until the loss is fully absorbed.
   • Taxpayers must adhere to deadlines for each type of relief:
   • Carry-Across and Carry-Back: 31 January following the tax year.
   • Carry-Forward: Four years after the tax year of the loss.
     3. Example of Combination:
   • A taxpayer may first use carry-back relief to reclaim taxes paid in earlier years, then carry forward any remaining loss to offset future profits.

Question 21

What are the key deadlines for claiming trading loss reliefs?

Answer 21

1. Start-Up Loss Relief:
   
   • Claim by 31 January of the year following the tax year of the loss.
     2. Carry-Across and One-Year Carry-Back Relief:
   • Claim by 31 January of the year following the tax year of the loss.
     3. Set-Off Against Capital Gains:
   • Claim by 31 January of the year following the tax year of the loss.
     4. Carry-Forward Relief:
   • Notify HMRC within four years of the end of the tax year in which the loss occurred.

Question 22

What are some key considerations when choosing a loss relief strategy?

Answer 22

1. Personal Allowance Impact:
   
   • Losses applied to total income may reduce income to £0, causing the taxpayer to lose the benefit of their personal allowance.
     2. Immediate vs. Long-Term Benefits:
   • Start-up loss relief and carry-back relief provide immediate tax rebates.
   • Carry-forward relief preserves the personal allowance and helps avoid higher tax rates in future profitable years.
     3. Tax Bands:
   • Using losses in years with higher tax rates (e.g., 40% or 45%) provides more significant benefits than in years with lower rates.
     4. Trade Profitability:
   • Carry-forward relief is less useful if the business does not become profitable.