lecture 2 - business/trading income

Answer 1

the tax bands, the tax rates, the basis of assessment

Question 2

what is business/trading income?

Answer 2

income that meets the ‘badges of trade’

Question 3

what are the badges of trade generally?

Answer 3

they are used to determine if a transaction is capital or trade. this is needed to determine which of the trader’s accounts will form the basis period for the tax year. these accounting profits will then be adjusted to derive TATP for use in tax computation.

Question 4

what are the 9 badges of trade?

Answer 4

motive of transaction

supplementary work and marketing - is there an organised effort to obtain profit?

frequency of transactions

length of ownership - longer tends to capital

the way the asset is sold - forced tends away from trade.

the subject matter of the transaction - do you get utility from asset?

the source of finance for the transaction

the method of acquisition - inheritance items that are expensive to maintain for example, when selling may not count as trade.

the existence of similar trading transactions or interests

Question 5

Wisdom v Chamberlain 1968

Answer 5

A taxpayer purchased two large quantities of silver bullion to counter the effects of the devaluation of the pound. The purchase was made following advice and was partly financed by loan. As the purchase was done on a short term basis in order to realise profit. There was an adventure in the nature of trade and was therefore assessed as trading profit.

Question 6

what must you do if you are making business/trading income? what do you pay after this point?

Answer 6

register the business with HMRC.

from reg, you will need to pay:
class 2 NI at £3.45 per week if profits greater than 12570.
Class 4 NI at 9% profits over 12570, up to 50270 then 2%.

tax payable on income over personal allowance of 12570 at 20%, for first 37700 over PA. (so up to 50270).

Question 7

how do you determine if a trading expense is deductible?

Answer 7

the wholly and exclusively test: the expense was incurred wholly and exclusively for the purpose of trade.

Question 8

what tests are used to prove a transaction meets the wholly and exclusively for trading?

Answer 8

remoteness - is the expenditure sufficiently related to trading activity? subscriptions to trading associations okay, political parties not so much.

duality - is there a private as well as business benefit? need to clearly identify business portion of the expenditure if so.

Question 9

is revenue deductible?

Answer 9

yes - no capital transactions are deductible. there is no legal definition, all based on case law. capital = asset with enduring benefit generally. revenue consumed immediately.

repairs to assets are generally deductible, improvements are not. professional fees or charges related to capital assets are not deductible

Question 10

is entertainment/gifts for staff deductible as a trading expense?

Answer 10

yes - if for staff

Question 11

is training for staff deductible as a trading expense?

Answer 11

yes if it’s of an updating nature

no if it’s for a brand new skill

Question 12

are donations deductible as a trading expense?

Answer 12

yes for a small donation that reasonably helps trade

no for donations to large/national charities

Question 13

are gifts to customers deductible as a trading expense?

Answer 13

yes if less than £50 with conspicuous advertisement of the company on it, and not food/drink/tobacco.

if over £50, the entire amount is not deductible, rather than the excess.

Question 14

are goods taken for personal use deductible as a trading expense?

Answer 14

no! and taxable on net profit of disposition at market value

Question 15

are depreciation and amortisation deductible as trading expenses?

Answer 15

no - they are related to capital expenditure

Question 16

are fines/penalties/illegal payments deductible as a trading expense?

Answer 16

all fines by directors and proprietors disallowed, parking fines for employees on business okay.

Question 17

is appropriation of profit deductible as a trading expense?

Answer 17

no - net profit of business is all taxable

Question 18

is entertaining customers or suppliers deductible as a trading expense?

Answer 18

no - only staff

Question 19

are provisions deductible for trading purposes?

Answer 19

yes if they are specific/reasonably certain to arise. Deducted in year accrued, not paid.

Exceptions for payments to employees and pension contributions to employees.

Question 20

what happens if you can’t separate a transaction into business vs personal portions?

Answer 20

the entire amount is not deductible.

Question 21

mallelieu vs drummond 1983

Answer 21

A barrister tried to claim the cost of a black dress, a suit, shoes and a white blouse that was required when making court appearances. The costs or replacement and laundering was included. The barrister claimed that the expense was only in relation to the Bar Councils dress code and contended that these clothes would not normally be purchased. The expense was no allowed due to the dual purpose of the expenditure. The clothing enabled the barrister to be warm and properly clad as well as allowing her to work in her profession.

Question 22

caillebotte v quinn 1975

Answer 22

A self-employed subcontract carpenter tried to claim the excess of lunch costs when working away from home. The lunch has a duality of purpose and was therefore not allowed. The case famously made the quote:

“a Schedule C taxpayer, like any other taxpayer, must eat in order to live; he does not eat in order to work.”

Question 23

define TATP

Answer 23

tax adjusted trading profit - difference between trading receipts and allowable expenses during period of assessment. calculated through accruals, cash or trading allowance.

Question 24

how is TATP calculated?

Answer 24

take net profit per accounts. add: expenditure not deductible for tax purposes, income which is taxable but not directly credited to P&L account. less: income in accounts which is not taxable, expenditure not in accounts which is deductible for tax purposes. this gives you your tax adjusted trading income.

Question 25

how does the accruals basis work in terms of finding TATP?

Answer 25

Starts with net profit for accounting purposes, which inc all receipts that relate to relevant period whether received then or not. All relevant expenses are then deducted, these inc all those relating to period you are computing for, whether paid in period or not. Adjustments then to find TATP.

Question 26

what are the new rules for the accounting year end assessments?

Answer 26

tax assessed on profits attributable to tax year, 6 april to 5 april. therefore, if you maintain accounts that do not coincide with these dates you will need to prorate your profits, based on number of days, within that tax year.

if you have 31st dec year end, taxed on (270/365) x annual profits year ended 31 December 2024 + (95/365 x annual profits year ended 31 December 2025.

This arguably increases overall horizontal equity of tax system. Will not affect most small businesses, as most already have tax-aligned year ends.

Question 27

what are the turnover requirements for the cash basis?

Answer 27

turnover less than 150K. 300K for universal credit recipients. Cash basis rules apply for all businesses individual runs either as sole trader or ptship, i.e. can’t split up businesses to stay under the threshold. Also can’t use if you claim R&D allowances, or in the mineral extraction trade.

Question 29

How are bad debts treated in regard to trading income?

Answer 29

trade debts written off are deductible in the year the debt becomes bad/doubtful

Question 30

Are redundancy payments allowed as a trading expense?

Answer 30

if meet wholly and exclusively test, allowed without limit if business continues to trade. if ceases to trade, limited to stat payment + up to 3xstat payment.

Question 31

what is the treatment for profits in the wrong account (e.g. sale of investments in the trading profits and losses account?)

Answer 31

if they will be taxed wrongly (e.g. here should be CGtax not Corptax), then deduct them from the profit.