Income from self-employment Flashcards
What is a trading income?
- the profits of an unincorporated trader arising form a trade, profession or vocation
Who is referred as self-employed or sole traders?
- individuals with an unincorporated business
What means current year basis? (CYB)
- the profits assessed in a tax year are those of the twelve month period of account ending in that tax year
What is known as badges of trade?
- to determine whether an individual is trading, a number of tests
What are badges of trade SOFIRM and FAST?
- S- the subject matter of the transaction
(are the goods of a type normally used for trading?) - O - the length of the period of ownership
(a short period of ownership is more likely to indicate trading) - F- the frequency of similar transactions by the same person
(frequent transactions indicate trading) - I - supplementary work, improvements and marketing
(work performed on goods to make them more marketable indicates trading - R- the circumstances/reason for the sale
(a forced sale to raise cash indicates not trading) - M - motive
(intention to profit may indicate trading) - Finance F
- where the taxpayer took out a loan to buy the asset which he, she of they expects to repay from the proceeds of sale
- Method of acquisition A
- where the taxpayer acquired the asset by way of purchase rather than receiving it as a gift or by inheritance
- Existence of similar trading transactions ST
- where the transactions are similar to those of an existing trade carried on by the taxpayer
Subject matter of the transaction
Asset has been acquired for one of three reasons:
- an investment
capital in nature and not subject to income tax
- goods for private use of individual (or family)
no subject to tax
- trade inventory
a trading transaction and subject to income tax
The length of the period of ownership
- the longer the period between acquisition and disposal, the more likely the transaction will not be treated as trading
What are the four types of adjustment that need to be made to move from accounting profit to the tax adjusted trading profit?
- Expenditure which tax law prevents from being an allowable deduction may be charged in the statement of profit or loss
- add back to accounting profit - Taxable trading income may not be included in the statement of profit or loss
- add to accounting profit - Expenditure that is deductible for tax purposes may not charged in the statement of profit or loss
- deduct from accounting profit - Income may be included in the statement of profit of loss that is not taxable as trading income
- deduct from accounting profit
Pro forma - Tax adjusted trading profit
Net profit accounts x
Add:
Expenditure not allowed for taxation purposes x
Expenditure allowable for taxation purposes 0
Taxable trading profit not credited in the accountsx
Less:
Expenditure not charged in the accounts but allowable for taxation purposes x
Income included in the accounts that is not taxable as trading profit x
Capital allowances x
What is the general rule to follow in deciding whether expenditure is an allowable deduction from trading profits?
- is that only expenditure incurred wholly and exclusively for the purposes of the trade is allowable
When expenditure may be disallowed?
- it is too remote from the purposes of the trade - the remoteness test
- it has more than one purpose and one of them is not trading - the duality principle
What are the appropritions?
- are the withdrawal of funds from a business (i.e. profit extraction rather than expenses incurred in earning them) and, as such, are disallowed expenses
What are the most common examples for appropriations?
- interest paid to the owner on capital invested in the business
- salary/drawings taken by a sole trader or partner
- any private element of expenditure relating to the owner’s car, telephone etc.
Excessive salary paid to a sloe trader’s family
- any salary paid to the family of the owner o an unincorporated business is allowable provided it is not excessive
- it must be remuneration at the commercial rate for the work performed
Is interest payable allowable trading expenses - accrual basis
- yes, interest on borrowings such as business account overdrafts, credit cards, hire purchase contracts
- not interest for HMRC late payments…
Capital expenditure
- is not allowable trading expense
- any form of depreciation, loss - not allowable
- revenue expenditure - allowable
What are the difference between repairs and improvement regarding capital expenditure?
- the cost of initial repairs in order to make an asset usable is disallowed
- the cost of initial repairs is allowed if the asset can be put into use before any repairs are carried out
- capital expenditure on plant and machinery and structures and buildings is disallowed but may qualify for capital allowances
Car leasing
-rental and lease charges payable in respect of leased cars are allowable where the CO2 emissions of the car are 50g/km or less
- where CO2 emissions exceed 50g/km, 15% of the rental/lease charges are disallowed
Trade or professional subscription
- are normally deductible since they are made wholly and exclusively for the purposes of the trade
What a charitable donation must meet to be allowable?
- wholly and exclusively for trading purposes
- local and reasonable in size in relation to the business making the donation
- made to a registered charity
Can be entertaining and gifts allowed expenditure?
-no
- only exception is for expenditure relating to employees, provided it is not incidental to the entertainment of others
Can be gifts to employees allowed expenditure?
- yes
- care must be taken, however, as the gift may fall within the benefit rules and be assessed on the employee as employment income
Can be gifts to customers allowed expenditure?
Only if:
- they cost less than £50 per recipient per year
- the gift is not of food, drink, tobacco or vouchers exchangeable for goods
- the gift carries a conspicuous advertisement of the business making the gift
Gifts of business samples to advertise the goods to the public are allowable
Are legal and professional charges allowable?
- yes, if is incurred for the purposes of the trade
Examples: - legal fees chasing trading debts
- charges incurred in defending the title to non-current trade assets
Examples of expenditure of capital nature/disallowable
- fees associated with acquiring new non-current assets
Exceptions: - fees and other costs of obtaining long-term debt finance are allowable for a sole trader
- the cost of registered patents is allowable
- renewing a short lease
What is allowable or not in impairment losses and allowances for trade receivables
yes:
- the write-off of a trade debt
- an allowance for the irrecoverability or impairment of trade receivables
no:
- the write off of a non-trade debt
What types of expenditure are in other items allowed?
- provisions for future costs: provided they are calculated in accordance with UK GAAP
- compensation for loss of office paid to an employee: only if for benefit of trade
- redundancy pay to an employee in excess of the statutory amount: limited if due to cessation of trade, to a maximum of 4 x the statutory amount
- counselling services for redundant employees
-damaged paid: only if paid in connection with trade matter and is not a fine for breaking the law - defalcations (theft/fraud) only if by employee, not the business owner/director
- educational courses: only if for trade purposes
- pension contributions to registered pension scheme: if for employees - provided paid by the year end
- premiums for insurance against an employee’s death or illness
- removal expenses: provided not an expansionary move
- salaries accrued at year end: provided paid not more than 9 months after year end
What types of expenditure are in the other items disallowed?
- fines: unless parking fines incurred on business by employee, but not business owner/director
- payment that constitutes a criminal offence
Taxable trading income not included in the statement of profit or loss
- the trader is treated for tax purposes as making a sale based on the selling price of the goods concerned
- note that this rule does not apply to the supply of services
What are the deductible expenditure not charged in the statement of profit or loss
- capital allowances
- allowable trading element of lease premiums paid on short leases
- where a business owner uses his, her or their private residence partly for business purposes the business portion of running expenses is allowable
- business calls from the private telephone of the sole trader
- expenses that are wholly and exclusively for the trade that have been met from the private funds of the owner
Short lease premiums
- when a landlord receives a premium for the grant of a short lease, a proportion of the lease premium is charged to income tax on the landlord as property income
- where a business pays a premium for a short lease on premises for business use, a proportion of the amount taxable on the landlord as property income can be deducted as an expense for the tenant, in calculating their taxable trading profit
The tax adjustments required for a lease premium in a trader’s annual accounts are:
Add back:
the amortisation charged in the statement of profit or loss
Deduct:
allowable expenses proportion of the lease premium
Property income taxable on the landlord calculation
P less (P x 2% x (n-1)) or P x (51-n)/50
where P = total premium
n = duration of lease in years
What are the three categories of income which need to be adjusted for? (trading income)
- capital receipts
- other forms of income ( such as savings income, property income or dividends) must be deducted in arriving at the taxable trading profit
- income that is exempt from tax
(such as interest received on overpaid income tax)
Relief for pre-trading expenditure
- any revenue expenditure, incurred in the seven years before a business starts to trade, which would have been allowable if the business was trading, is treated as an expense on the day that the business starts trading
Cash basis option for small businesses
- just for unincorporated business - sole traders, partnerships
- provided they have annual cash receipts of not more than £150,000
- if cash basis, it can continue to account on this basis until its annual cash receipts exceeds £300,000
Cash base for trading income
- the business accounts for cash receipts and payments in the period of account, i.e. period for which the business prepares accounts
- there is no distinction between capital and revenue expenditure in respect of plant, machinery and equipment for tax purposes, therefore: - purchases are allowable deductions when paid for,
- proceeds are treated as taxable cash receipts when an asset is sold
- capital allowances remain available for expenditure on cars only, the capital cost of a car is not an allowable deduction when paid - expenditure on buildings cannot be deducted when paid; structures and building allowances can be claimed in respect of qualifying expenditure
What are the key advantages of cash basis?
- simpler accounting requirements are there is no need to account for receivables, payables and inventory
- profit is not accounted for and taxed until it is realised therefore cash is available to pay the associated tax liability
What is the main disadvantage of cash basis?
- losses can only be carried forward to se against future trading profits, whereas under the accruals basis many more options for loss relief are available
Flat rate expense deduction option for any unincorporated business
- opt to use flat rate expense adjustments
- to replace the calculation of actual costs incurred in respect of certain expenses
What is the flat rate expense adjustment for car expenses - capital costs and running costs (e.g. insurance, repairs, servicing and fuel)
Allowable deduction
= amount using the AMAP rates of 45p and 25p per business mile (i.e. same allowance as for property businesses and employed individual’s use of own car)
What is the flat rate expense adjustment for private use of part of a commercial building - private accommodation in a guest house or small hotel (e.g. a bed and breakfast)
Private use adjustment re household goods and services, rent, food and utilities
= fixed amount based on the number of occupants
Note that the private element of other expenses
(e.g. mortgage interest and building rates) must be adjusted for as normal
