Sole Traders – Trade profits Flashcards
Is a trade being carried out? Badges of trade Adjustments to profits Disallowable expenditure Trading income not included in the accounts Income not taxed as trade Capital allowances Trading allowance
What tax is paid if an individual’s sales are considered part of a trade?
If the sale is considered part of a trade, any profits will be taxed as trading income and will be subject to income tax and National Insurance.
What tax is paid if the sales are not considered a trade?
If the sale is not considered a trade, any profits may be taxed as capital gains and will suffer capital gains tax (CGT).
What are the 8 Badges of Trade that HMRC uses to determine if a person is trading?
Profit-seeking motive – Was the asset purchased with the intention of making a profit?
Number of transactions – Is this a one-off sale, or has the individual sold similar items multiple times?
Nature of the asset – Is the asset something that is typically held for investment, or does it indicate trading?
Existence of similar trading transactions or interests – Does the individual have a business dealing with similar assets?
Changes to the asset – Has the asset been altered or improved before the sale?
The way the sale was carried out – Was the sale conducted in the same manner as a trader (e.g., through an agent)?
The source of finance – Was money borrowed specifically to purchase the asset for resale?
Interval of time between purchase and sale – Was the asset held for a long time (investment) or sold quickly (trading)?
What 2 objectives do we have when adjusting accounting profit for tax purposes?
Ensure that only trading income is included.
Ensure that only allowable trading expenses are deducted.
What 4 key adjustments must be made when adjusting trading profits?
Add back disallowable expenditure.
Add any trade income that was not included in the accounts.
Deduct income that is taxed separately (not as trading income).
Deduct capital allowances, if applicable.
What 2 conditions must be met for an expense to be allowable for tax purposes?
The expense must be incurred wholly and exclusively for the purpose of the trade.
If an expense has a dual purpose, only the business portion is allowable.
What 3 types of fines and penalties are disallowed?
Fines for breaking the law (e.g., speeding tickets, regulatory fines).
Penalties incurred by the business owner.
Legal and professional fees associated with law-breaking.
What 2 conditions determine whether donations are allowable?
Donations to political parties are disallowed.
Donations to national charities are disallowed, but donations to local charities may be allowed if they serve a business purpose (e.g., marketing or sponsorship)
What 2 types of capital expenditure must be disallowed?
The purchase of assets (capital in nature).
Any improvements made to an asset, as these are not revenue expenses.
What 2 types of depreciation-related adjustments must be made?
Depreciation must be added back because it is not allowable.
Profit/loss on disposal of assets must be adjusted, as this is linked to depreciation
What 2 conditions determine if leased car expenses are partly disallowable?
If the car’s CO2 emissions exceed 50g/km, 15% of the lease cost is disallowed.
The remaining 85% of the lease cost is allowable.
What 2 examples of legal and professional fees are disallowed?
Legal fees for purchasing land or buildings.
Fees for acquiring or renewing long leases.
What 2 conditions determine if gifts to customers are allowable?
The gift must cost less than £50 per year per customer.
The gift must have a clear business advertisement and not be food, drink, tobacco, or cash.
What 2 types of bad debts are allowable and disallowable?
Specific bad debts (identified as uncollectible) are allowable.
General provisions (such as estimating doubtful debts as a percentage of sales) are disallowable.
What 2 private expenditures must be added back?
Personal use of business goods (added back at selling price, not cost price).
Expenses with private use (e.g., if fuel costs include 40% private use, that portion must be added back).
What 2 conditions determine if wages and salaries are allowable?
Owner’s salary is disallowed (it is considered drawings).
Wages for relatives must be reasonable; excessive salaries must be adjusted (e.g., if a family member is paid £100,000 but the market rate is £30,000, then £70,000 is disallowed).
What 2 scenarios require income to be added back to trading profits?
Income mistakenly omitted from the accounts due to accounting errors.
Goods taken for personal use must be added back at selling price.
What 4 types of income must be deducted from trading profits because they are taxed separately?
Interest received (taxed as investment income).
Dividends received (taxed separately under dividend rules).
Property rental income (taxed under property income rules).
Capital gains on asset disposals (taxed under capital gains tax rules).
What 2 reasons do HMRC allow capital expenditure deductions only under capital allowance rules?
Capital expenditure is disallowed as a trading deduction, but tax relief is available via capital allowances.
Capital allowances provide structured relief over time, instead of allowing immediate full deduction.
What if the sole trader’s accounting period does not match the tax year?
Two sets of accounts are needed, with profits time apportioned to fit the tax year.
What is the tax year basis for sole traders from 2024/25 onwards?
Profits are assessed on the tax year basis (6th April to 5th April), with profits time apportioned if the accounting period doesn’t match
What happens if the accounting period matches the tax year?
One set of accounts is needed for the tax return.
What happens if the accounting period doesn’t match the tax year?
Two sets of accounts are needed, and profits must be time apportioned
What is the trading allowance?
If income is below £1,000, it’s exempt from tax.
What if income exceeds £1,000?
The trader can either deduct business expenses as usual or use the trading allowance to exempt the first £1,000 of income.
Jamie earned £900. Does Jamie need to declare or pay tax on this income?
No, Jamie doesn’t need to declare or pay tax since the income is below £1,000, and he qualifies for the trading allowance.
Sarah earned £1,200 and had £250 in expenses. What would her trade profit be under the normal method?
£950 profit (£1,200 income - £250 expenses).
What would Sarah’s trade profit be if she used the trading allowance method?
£200 profit (£1,200 income - £1,000 trading allowance)
Which method would Sarah prefer to use?
Sarah would prefer the trading allowance method, as it results in a lower taxable profit.
Jennifer earned £5,000 with £1,200 in expenses. What would her trade profit be under the normal method?
£3,800 profit (£5,000 income - £1,200 expenses).
What would Jennifer’s trade profit be if she used the trading allowance method?
£4,000 profit (£5,000 income - £1,000 trading allowance).
Which method would Jennifer prefer to use?
Jennifer would prefer the normal method, as it results in a higher profit after expenses.
