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Principles of Tax > Ch 5 - Trading profits > Flashcards

Ch 5 - Trading profits Flashcards

1
Q

What are the tests developed to determine whether a transaction is classified as trading or capital?

A
  • 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)
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2
Q

What is the difference between trading income and capital?

A

Trading = taxable under income tax

Capital = taxable under capital gains tax

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3
Q

What is trading income?

A

Profits of an unincorporated trader arising from a trade, profession or vocation are assessed as trading income

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4
Q

How are profits of an ongoing business assessed?

A

Current year basis

Profits assessed in a tax year are those of a 12 month acc period ending in that tax year

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5
Q

Who makes payments on account, and what is it a payment on account for?

A

Sole traders make payments on account for income tax and NIC

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6
Q

What are the due dates for payments on accounts for income tax and NIC?

A

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

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7
Q

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?

A

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)

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8
Q

What are the adjustments made to trading profits for an accounting period?

A

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

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9
Q

What is the most common example of taxable trading income not included in the accounts?

A

When a sole trader removes goods from the business for their own use

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10
Q

What does the treatment of taxable trading income not included in the accounts depend on?

A

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
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11
Q

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%

A

Profit element = £700 * 30% = £210

Sale 130% = £910
Cost (100%) = £700
Profit = 210 (B)

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12
Q

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%?

A

Profit element = £700 * 30/70 = £300

Sale 100% = £100
Cost (70%) = £700
Profit = 300 (B)

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13
Q

What are the 2 types of non-trading income that should be removed from the accounts?

A
  • Income taxed elsewhere e.g. chargeable gains, rental income or savings income
  • Income that is exempt from tax e.g. exempt capital gains
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14
Q

When is expenditure allowed?

A

It must be incurred wholly and exclusively for trading purposes

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15
Q

When is expenditure unlikely to meet the definition of allowable expenditure?

A
  • 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

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16
Q

What is an appropriation?

A

Withdrawal of funds from a businesses’ profits

They are disallowable expenses

Examples include:

  • Business owner’s salary
  • Drawings made by a sole trader/ partner
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17
Q

Give some examples of appropriation

A
  • Business owner’s salary

- Drawings made by a sole trader/ partner

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18
Q

How is expenditure on/relating to capital assets treated?

Give some examples of things commonly needing to be added back

A

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)

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19
Q

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

A

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

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20
Q

Are repairs and maintenance allowable expenses?

A

Note: repairs and main are allowable costs unless such expenditure is required to bring an asset into useable state (classed as capital expenditure)

21
Q

What is the disallowance on the tax comp for car leasing and rental costs and what does it apply to?

A

Flat rate disallowance of 15% of the following car lease payments:

22
Q

What is the disallowance on the tax comp for car leasing and rental costs and what does it apply to?

A

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

23
Q

What is the required treatment of impaired debts?

A

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

24
Q

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

A

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

25
Q

How are entertaining and gifts treated?

A

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
26
Q

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

A

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

27
Q

What is the appropriate treatment of donations as expenses?

A

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
28
Q

What is the appropriate treatment of legal and professional charges?

A

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

29
Q

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

A

Add back
Drawings £10,600 as not wages
Excess payment to son (15k-12k) = £3,000

30
Q

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.

A

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

31
Q

TYU5: Is the following expense allowable?

Advertising costs of £4,500 include £3,100 of client entertaining

A

Now allowable, add back £3,100

32
Q

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

A

Add back
Political £40,000
Charitable £14,000

33
Q

What is the appropriate treatment of legal and professional charges?

A

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
34
Q

Are fines allowable?

A

Fines are generally disallowable but parking fines incurred by an employee (but not the business owner) whilst on work business are allowable

35
Q

Is interest allowable?

A

Interest on borrowings for the purpose of trade is allowable (e.g. business account overdraft)

Interest on late paid tax is disallowable

36
Q

Is irrecoverable VAT allowable?

A

If it relates to allowable expenditure then it is allowable

37
Q

Is the following allowable, disallowable or a deductible expense, and give your reason

Drawings of a proprietor

A

Disallow - appropriation of profit therefore add back

38
Q

Is the following allowable, disallowable or a deductible expense, and give your reason

£55 parking fines incurred by employee on business

A

Allowed as its an employee on business,

39
Q

Is the following allowable, disallowable or a deductible expense, and give your reason

£2,000 on party for 5 employees

A

Staff entertaining is allowable, no upper limit for the employee

40
Q

Is the following allowable, disallowable or a deductible expense, and give your reason

Subscription to golf club where sole trader may meet/ entertain clients

A

Disallow, not wholly and exclusively for the purposes of trade

41
Q

Is the following allowable, disallowable or a deductible expense, and give your reason

£400 on legal expenses to acquire a short lease (7 years)

A

Disallow Legal fees on RENEWAL only are allowed, so add back the acquisition legal fees

42
Q

Is the following allowable, disallowable or a deductible expense, and give your reason

£100 donation to Conservative Party

A

Disallow

prolitical donations aren’t allowed

43
Q

Is the following allowable, disallowable or a deductible expense, and give your reason

£650 for trade related NVQ training course for apprentice employee

A

Allowed

Providing the course is for the purpose of trade its allowable

44
Q

Is the following allowable, disallowable or a deductible expense, and give your reason

Depreciation of £7,500

A

Disallow

Relates to capital expenditure

45
Q

Is the following allowable, disallowable or a deductible expense, and give your reason

Dividends received of £5,000

A

Deduct

Amount is taxable, but not as trading income

Deduct £5k from trading income and include in calc of net income on tax comp

46
Q

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

A

Disallow

Full £2,000 not allowed as it is alcohol

47
Q

What is the trading allowance?

A

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

48
Q

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

A

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

Principles of Tax (11 decks)

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