Ch 5 - Trading profits Flashcards
What are the tests developed to determine whether a transaction is classified as trading or capital?
- Subject matter of the transaction (whether an asst has been bought for personal use, investment or for resale
- Method of acquisition and source of finance (inherited assets are less likely to be trade, but ST finance to buy/improve is trading activity)
- Length of ownership period (shorter period = trading?)
- Frequency of similar transactions by same person (high freq indicates trading?)
- Circumstances responsible for realisation (force to make sale for cash doesn’t indicate trading)
- Motive (if intention is to profit= trading)
What is the difference between trading income and capital?
Trading = taxable under income tax
Capital = taxable under capital gains tax
What is trading income?
Profits of an unincorporated trader arising from a trade, profession or vocation are assessed as trading income
How are profits of an ongoing business assessed?
Current year basis
Profits assessed in a tax year are those of a 12 month acc period ending in that tax year
Who makes payments on account, and what is it a payment on account for?
Sole traders make payments on account for income tax and NIC
What are the due dates for payments on accounts for income tax and NIC?
First POA = 31 January in tax year
Second POA = 31 July following the end of the tax year
Balancing payment = 31 Jan following end of tax year
If A prepares her accounts for the year ended 31 Dec 2018, what tax year are her profits assessed in and when are her payments on account in the year 2019 and 2020?
Profits assessed in 18/19 tax year
makes POA on 17/18 liability on 31 Jan 2019 and 31 July 2019
Balance will be due on 31 January 2020, along with self assessment tax return (for 18/19)
What are the adjustments made to trading profits for an accounting period?
Net profit per accounts
Add: disallowable expenditure
Add: taxable trading income not credited in the accounts
Less: Allowable expenditurenot charged in the accounts
Less: Income include in the accounts that isn’t taxable trading income
Less: capital allowances
= Tax adjusted trading profit
What is the most common example of taxable trading income not included in the accounts?
When a sole trader removes goods from the business for their own use
What does the treatment of taxable trading income not included in the accounts depend on?
The treatment in the accounts
- If correctly treated in the accounts, i.e. cost has been removed from purchases, then it is added back to the profit element
- If it is still included in purchases i.e. no adjustments made in the accounts, then add back selling price
TYU1 : Terry operates a hardware store and has taken goods for his own use costing £700 during y/e 31 Dec 18
costs have already been debited to his drawings account
Whats the increase to net profit required if
a. Terry operates a mark-up basis of pricing of 30%
Profit element = £700 * 30% = £210
Sale 130% = £910
Cost (100%) = £700
Profit = 210 (B)
TYU1 : Terry operates a hardware store and has taken goods for his own use costing £700 during y/e 31 Dec 18
costs have already been debited to his drawings account
Whats the increase to net profit required if
b. Terry operates a gross profit margin of 30%?
Profit element = £700 * 30/70 = £300
Sale 100% = £100
Cost (70%) = £700
Profit = 300 (B)
What are the 2 types of non-trading income that should be removed from the accounts?
- Income taxed elsewhere e.g. chargeable gains, rental income or savings income
- Income that is exempt from tax e.g. exempt capital gains
When is expenditure allowed?
It must be incurred wholly and exclusively for trading purposes
When is expenditure unlikely to meet the definition of allowable expenditure?
- It is too remote for the purposes of the trade
- it has both a trade and non-trade purpose (the duality principle)
Where expenditure has been incurred for both trading and non-trading purposes, a deduction can be claimed for the business use proportion
What is an appropriation?
Withdrawal of funds from a businesses’ profits
They are disallowable expenses
Examples include:
- Business owner’s salary
- Drawings made by a sole trader/ partner
Give some examples of appropriation
- Business owner’s salary
- Drawings made by a sole trader/ partner
How is expenditure on/relating to capital assets treated?
Give some examples of things commonly needing to be added back
Not allowed in computing the taxable trading profit
May be allowed for capital gains tax
Examples
- Depreciation
- Loss on sale of fixed assets
- Cost of capital assets included within repairs and maintenance
- Improvements/enhancements
- Capital related expenditure included within L&P fees
Note: repairs and main are allowable costs unless such expenditure is required to bring an asset into useable state (classed as capital expenditure)
TYU2: Carlo is a self-employed plumber. During the acc period, Carlo drove 16,900 miles (11,200 were for business)
Motor expenses amounted to £11,500
Calc the amount of Chris’ motor expenses that need to be disallowed in the taxable trading profit computation
If 11,200 are for business purposes, remaining 5,700 are for private purposes
So need to disallow 4,700/16,900 x £11,500 = £3,879
Are repairs and maintenance allowable expenses?
Note: repairs and main are allowable costs unless such expenditure is required to bring an asset into useable state (classed as capital expenditure)
What is the disallowance on the tax comp for car leasing and rental costs and what does it apply to?
Flat rate disallowance of 15% of the following car lease payments:
What is the disallowance on the tax comp for car leasing and rental costs and what does it apply to?
Flat rate disallowance of 15% of the following car lease payments:
- For leases taken out before 6 April 2018 w CO2 emissions above 130g/km
- Leases taken out on/after the date where CO2 emissions exceed 110g/km
If leased car is used by ST partly for business, partly for private, then there is a disallowance for private use
What is the required treatment of impaired debts?
Movements in specific provisions are allowable but movements in general provisions are disallowable
Write-off of trade bad debts is allowable, but w/o of non-trade bad debts is disallowable and therefore needs to be added back
TYU3: Sheila and Ray are both sole traders preparing acc to 31 Dec
Sheila incurs annual rental expenditure of £3,512 on leasing a car w CO2 emissions of 118g/km (first leased 1 June 18)
Only uses the car for business purposes
Ray has leased the same car since 2014/ Car has emissions of 180g/km and lease payments are £700/month with 80% business use.
Show the amount aded back to profit in the year ended 31 Dec
SHEILA
Annual rental payments are £3,512
For 7 months to 31 Dec 18 charge is 3,512 x 7/12 = £2,049
Therefore disallow £2,049 * 15% = £307
RAY
Annual rental payment = £700 * 12 = £8,400
Allowable amount = £8,400*85% * 80% (bus use) = £5,712
Therefore, disallow £8,400 - £5,712 = £2,688
How are entertaining and gifts treated?
Expenditure relating to client entertaining is disallowable
Staff entertaining is allowable
Gifts to employees are normally allowable expenditure- there is no upper limit (unlike for benefits in kind)
However, gifts may result in income tax charge for employee under the benefit rules
Gift of trade samples to customers is allowable
Other gifts to customers are disallowable unless the item is
- Cost < £50 per recipient per year
- Not food, drink, tobacco or vouchers exchangeable for goods
- Carries a conspicuous advertisement for the business
TYU4: Siobhan has a net profit in her acc of £25,829.
Given the following info on impaired debts:
Increase in specific provision (£5,194 - £4,185) = £1,009
Amounts written off:
- Trade receivable £8,129
- Former employee loan written off £50
- Recoveries (trade debts recovered) = £(6,023)
Impaired receivable expense charged = £3,165
Calculate Siobhan’s tax adjusted trading profit assuming all other expenses are allowable
Specific provision - allowable
Trade receivable = allowable
Former employee loan writer off - not allowable
Recoveries (trade debt recovered) - allowable
So only need to add back former employee loan w/off as acts as a non-trade loan
Debt write offs must be related to normal trade debts
What is the appropriate treatment of donations as expenses?
Depends on nature of the organisation being donated to
- Small donations to local charities are allowable
- Gifts of stock/assets to local charities/schools are allowable
- Donations to national charities are disallowable but tax relief may be available through Gift Aid Scheme
- Donations to political parties are disallowable
What is the appropriate treatment of legal and professional charges?
Allowable if incurred for the purposes of the trade
E.g. legal fees chasing debts or charges incurred in defending the title to fixed assets
Expenditure of capital nature is disallowable e.g. fees associated with acquiring new fixed assets
Exceptions to these rules:
- Fees and other costs of obtaining long term debt finance are allowable
0 Cost of registering patents is allowable
- Expense of renewing a short lease (a lease for 50 years or less) is allowable, although the legal expenses incurred on the initial granting of the lease are not
TYU5 : Is the following expense allowable?
Staff salaries of £45,500 that contain a self-employed mans own drawings of £10,600 and £15,000 paid to his son for being his gardening assistant. The other gardening assistant was paid £12,000
Add back
Drawings £10,600 as not wages
Excess payment to son (15k-12k) = £3,000
TYU5: Is the following expense allowable?
At Christmas, Anton gave his 2 assistants (one’s his son) £300 in supermarket vouchers
Also gave 100 of his customers a trowel bearing his logo at a cost of £20 each.
Vouchers for employees are allowable
Vouchers for the employees are allowable expenditure, as are the gifts to his customers since the trowels cost less than £50, aren’t food, drink, tobacco or vouchers exchangeable, and carry a conspicuous advertisement for the business
TYU5: Is the following expense allowable?
Advertising costs of £4,500 include £3,100 of client entertaining
Now allowable, add back £3,100
TYU6: Ayshah has a net profit in her accounts of £365,450
In calculating this profit, a deduction has been made for charitable donations as follows:
- Donation to political party £40k
- To local animal hospital £500
- To national charity £14,000
Calculate her tax adjusted trading profit, assuming all other expenses are allowable
Add back
Political £40,000
Charitable £14,000
What is the appropriate treatment of legal and professional charges?
Allowable if incurred for the purposes of the trade
E.g. legal fees chasing debts or charges incurred in defending the title to fixed assets
Expenditure of capital nature is disallowable e.g. fees associated with acquiring new fixed assets
Exceptions to these rules:
- Fees and other costs of obtaining long term debt finance are allowable
- Cost of registering patents is allowable
- Expense of renewing a short lease (a lease for 50 years or less) is allowable, although the legal expenses incurred on the initial granting of the lease are not
Are fines allowable?
Fines are generally disallowable but parking fines incurred by an employee (but not the business owner) whilst on work business are allowable
Is interest allowable?
Interest on borrowings for the purpose of trade is allowable (e.g. business account overdraft)
Interest on late paid tax is disallowable
Is irrecoverable VAT allowable?
If it relates to allowable expenditure then it is allowable
Is the following allowable, disallowable or a deductible expense, and give your reason
Drawings of a proprietor
Disallow - appropriation of profit therefore add back
Is the following allowable, disallowable or a deductible expense, and give your reason
£55 parking fines incurred by employee on business
Allowed as its an employee on business,
Is the following allowable, disallowable or a deductible expense, and give your reason
£2,000 on party for 5 employees
Staff entertaining is allowable, no upper limit for the employee
Is the following allowable, disallowable or a deductible expense, and give your reason
Subscription to golf club where sole trader may meet/ entertain clients
Disallow, not wholly and exclusively for the purposes of trade
Is the following allowable, disallowable or a deductible expense, and give your reason
£400 on legal expenses to acquire a short lease (7 years)
Disallow Legal fees on RENEWAL only are allowed, so add back the acquisition legal fees
Is the following allowable, disallowable or a deductible expense, and give your reason
£100 donation to Conservative Party
Disallow
prolitical donations aren’t allowed
Is the following allowable, disallowable or a deductible expense, and give your reason
£650 for trade related NVQ training course for apprentice employee
Allowed
Providing the course is for the purpose of trade its allowable
Is the following allowable, disallowable or a deductible expense, and give your reason
Depreciation of £7,500
Disallow
Relates to capital expenditure
Is the following allowable, disallowable or a deductible expense, and give your reason
Dividends received of £5,000
Deduct
Amount is taxable, but not as trading income
Deduct £5k from trading income and include in calc of net income on tax comp
Is the following allowable, disallowable or a deductible expense, and give your reason
100 gifts of Champagne to customers. Each bottle cost £20 and bears the business logo
Disallow
Full £2,000 not allowed as it is alcohol
What is the trading allowance?
Trading allowance of £1,000 applies to sole traders (not partnerships)
If a sole trader’s trading RECEIPTS (not profits) are less than £1,000 then they aren’t taxable and don’t need to be declared for tax purposes
If they are more than £1k, tax payer can elect to deduct the allowance from the receipts rather than any actual expenses incurred
Election applies to all of the indie’s of trades and relates to a specific tax year
Should assume that no election to use the trading allowance has been made, unless told otherwise
TYU8: Rana runs a business providing IT support services. her income for the year ended 31 march 2019 was £4,900 and she had tax allowable expenses for £890. Calculate Rana’s tax adjusted trading profit assuming she takes advantage of all beneficial claims
Rana’s income is more than £1k so must be declared for tax
But she can choose to deduct the trading allowance rather than actual expenditure
This is preferable in her case as expenditure comes to less than £1k
Makes tax adjusted trading profits £4,900 - £1,000 = £,900
