Chapter 5 - Trading profits Flashcards
What are badges of trade?
The badges of trade are key factors which indicate whether a trade is being carried on.
What are the nine badges of trade?
Profit seeking motive
The number of transactions
Nature of the asset
Existence of similar trading transactions or interests
Changes to the asset
The way the sale was carried out
Source of finance
Interval of time between purchase and sale
Method of acquisition
What do trading profits cover?
Trading profits cover income from a trade, profession or vocation.
Outline the pro-forma for calculating tax adjusted trading profit for sole traders and partnerships
What adjustments to trading profits are we concerned with when calculating taxable trading income for sole traders and partnerships?
- disallowable expenditure
- non-trade income
- income not shown in accounts
- expenditure not shown in accounts
What is the trading allowance?
A trading allowance is available to individuals who carry on a trade. The allowance is £1,000. If trading receipts for an individual (not partner) for a tax year are less than £1,000, those receipts are not taxable.
With regards to trading allowance, what if trading receipts exceed £1,000?
If the receipts are above £1,000 the individual has a choice between calculating their taxable trading income in the usual way, by deducting costs of sale to give taxable trading profits or, by election, deducting deemed expenses of £1,000 from the receipts with no further reduction for actual expenses - the individual will go down whichever route gives the lowest taxable income
What should be assumed in an exam with regards to the trading allowance?
In the exam always assume that the trading allowance applies if the receipts do not exceed £1,000, but if the receipts exceed £1,000 you should assume that no election to use the trading allowance has been made, unless told otherwise.
What is allowed expenditure?
Expenditure incurred wholly and exclusively for the purposes of the trade, not specifically disallowed by legislation.
With regards to allowable expenses, how is capital expenditure treated for taxable trading income for sole traders and partnerships?
Capital expenditure is a disallowable expense and therefore is added back to trading profits
What is important to remember about repairs to newly acquired assets to bring them to a working state with regards to allowable expenses?
Repairs to newly acquired assets in dilapidated state is treated as capital expenditure and therefore is a disallowable expense - other repairs are treated as revenue and therefore are allowable
With regards to allowable expenses, how is depreciation treated for taxable trading income for sole traders and partnerships?
Depreciation is a disallowable expense and therefore is added back to trading profits
With regards to allowable expenses, how is appropriation of profit treated for taxable trading income for sole traders and partnerships?
Appropriation of profit is a disallowable expense therefore if profit given has already deducted any profit appropriations these must be added back
What are the different appropriations of proift we are concerened? How do we adjust for them when calculating taxable trading income for sole traders and partnerships?
- payment of a ‘salary’ to a sole trader or partner - add back
- payment of a salary to a family member which is not reasonable remuneration for the services provided to the business - the excess amount over the salary which would be considered reasonable should be added back
- personal expenses paid by the business (e.g. personal income tax, NI, etc.) on behlaf of the sole trader or partner - add back
With regards to allowable expenses, how are provisions treated for taxable trading income for sole traders and partnerships?
- Provisions made against specifc items are allowable expenditure
- General provisions are a disallowable expense therefore the movement in provision from the prior year should be added back or deducted (depending on if provision is increased or decreased) to trading profits
With regards to allowable expenses, how are bad debts treated for taxable trading income for sole traders and partnerships?
- Trade bad debts are an allowable expense
- Non-trade bad debts (bad-debts made to friends, loans to employees, etc.) are disallowable expenses and therefore are added back to trading profits
With regards to allowable expenses, how is entertaining treated for taxable trading income for sole traders and partnerships?
- Staff entertainment is an allowable expense
- Customer entertainment is a disallowable expenses and therefore is added back to trading profits
With regards to allowable expenses, how are gifts treated for taxable trading income for sole traders and partnerships?
Gifts are treated as a disallowable expense unless they meet the following criteria:
* are to employees
* are trade samples (not for resale), limited to one per customer per year
* to customers if they; incorporate conspicuous advertisement for the business, are not food, drink, tobacco or vouchers exchangeable for goods and the total cost per customer is no more than £50
All other gifts are disallowable and therefore must be added back to trading profits
With regards to allowable expenses, how are donations to charity treated for taxable trading income for sole traders and partnerships?
- Small donations to local charities are allowable if the gift enhances the public image of the trade
- Donations to national charities and doantions made under Gift Aid are disallowable expenses and therefore are added back to trading profits
With regards to allowable expenses, how are political donations treated for taxable trading income for sole traders and partnerships?
Political donations are a disallowable expense and therefore are added back to trading profits
With regards to allowable expenses, how are subscriptions treated for taxable trading income for sole traders and partnerships?
- Trade and professional associations are an allowable expense
- Subscriptions that are not related to the trade or profession are disallowable expenses and therefore are added back to trading profits
With regards to allowable expenses, how are fines and penalties treated for taxable trading income for sole traders and partnerships?
- Most fines and penalties are disallowable expenses and therefore are added back to trading profits
- The exception is parking fines incurred by an employee (not a sole trader or partner) on a business activity, these are allowable expenses
With regards to allowable expenses, how is interest expenses treated for taxable trading income for sole traders and partnerships?
- Interest paid on money borrowed for business purposes (i.e. bank overdraft, loan interest) is an allowable expense
- Interest paid on late payment of tax is a disallowable expense and therefore must be added back to trading profit
With regards to allowable expenses, how are legal and professional expenses treated for taxable trading income for sole traders and partnerships?
- Legal and professioinal fees that are not relating to capital expenditure are allowable expenses
- Legal and professional fees (e.g. conveyancing, architects, surveyor’s fees) relating to capital expenditure are disallowable expenses except for the following specific exceptions: legal costs relating to the renewal of a short lease (50 years or less), costs of registration of a patent or copyright for trade use, incidental costs of raising long-term finance
With regards to allowable expenses, how is irrecoverable VAT treated for taxable trading income for sole traders and partnerships?
Irrecoverable VAT is an allowable expense only if the item of expenditure to which it relates is allowable.
With regards to allowable expenses, how employment payments treated for taxable trading income for sole traders and partnerships?
Earnings paid to employees are generally allowable (Must be paid within 9 months of the accounting period), this includes:
* tax and NIC (employers and employees)
* redundancy payments (On the cessation of trade, restricted to 3 times the amount of statutory redundancy pay)
* pension contributions to employees registered pension scheme in the accounting period of payment
Related payments for sole traders and partners (i.e. tax, NI, pensions) is appropriation of profit (as previosuly seen) and is a disallowable expense
With regards to allowable expenses, how are plant and machinery leasing and rental costs treated for taxable trading income for sole traders and partnerships?
The costs of hiring, leasing or renting plant and equipment , including cars, are allowable expenses.
However for leases taken out on cars with CO2 emissions > 50g/km, there is a disallowance of 15% - you have to disallow 15% of the costs of hiring, leasing or renting the car.
With regards to allowable expenses, how is the private use of leased plant and machinery treated for taxable trading income for sole traders and partnerships?
A proportion of the lease cost must be disallowed where there is private use by the sole trader or partner - the rate of disallowance will be dependent on the amount of personal use
This does not apply for private use by employees - only sole traders and partners
How is non-trade income adjusted for when calculating taxable trading income for sole traders and partnerships?
Any non-trade income in the accounts must be deducted from trading profit
What are the common examples of non-trade income for sole traders and partnerships?
- rental income
- profits/losses on the disposal of fixed assets
- investment income.
What is the most common example of trading profits not shown in accounts that will need to be adjusted for when calculating taxable trading income for sole traders and partnerships?
The main example of trading profit not shown in the accounts of the business arises when goods are taken from the business by the owner for personal use.
What is the treatment of goods taken by owner when calculating taxable trading income for sole traders and partnerships?
The owner must be taxed on the profit he would have made if the goods had been sold at market value. The adjustment will depend on how the transaction has been shown in the accounts:
* If nothing is recorded in the accounts, add back the selling price - the market value of the item
* If recorded as drawings in accounts at cost, add back the profit which would have been made on sale of the item - market value minus cost
What is the most common example of trading expenses not shown in accounts that will need to be adjusted for when calculating taxable trading income for sole traders and partnerships?
The main example of trading expenses not shown in the accounts of the business is business expenditure paid personally by the owner
What is the treatment of business expenditure paid personally by the owner when calculating taxable trading income for sole traders and partnerships?
Business expenditure paid personally by the owner is an allowable expense and needs to be deducted from the trading profit
Outline the method for calculating taxable trading income for sole traders and partnerships
1) Write out the pro-forma pictured
2) Add back any disallowable expenditure
3) Add back on income not shown in accounts
4) Deduct and non-trade income
5) Deduct any expenditure not in accounts
6) This will give adjusted profits before capital allowances
7) Less any capital allowances (see later chapter on how to calculate)
8) This will givve the adjusted taxable trading profit
Can these adjsutments be applied to companies?
A lot of the adjustments that are made to taxable profits for sole traders and partnerships are similiar to the adjustments made for companies in their corporation tax with some differences which we will see in later chapter
