Topic 2 - Business Income Tax Flashcards
What is the first step in determining if a profit is trading or capital?
Apply the Badges of Trade to assess whether the transaction is a trade or an investment.
How are trading profits taxed?
Trading profits are subject to Income Tax.
How are non-trading profits (capital gains) taxed?
Non-trading profits are subject to Capital Gains Tax, which is usually preferable due to lower tax rates.
What are the key factors considered under the Badges of Trade? 9
Badges of Trade:
• Nature of the asset
• Profit motive
• Length of ownership
• Number of transactions
• Connection with existing trade
• Supplementary work
• Way sale was carried out
• Method of acquisition
• Source of finance
Why is profit motive important in determining a trade?
If there is an intention to make a profit, the transaction is more likely to be classified as a trade.
How does the length of ownership affect the classification of a trade?
Short-term ownership is more indicative of trading, whereas long-term ownership suggests an investment.
How does the number of transactions impact the classification?
Frequent transactions suggest trading, while a one-off sale is more likely a capital gain.
What role does connection with an existing trade play in classification?
If the asset is related to an individual’s existing business, it is more likely to be classified as trading income.
Select which TWO of the following statements indicate that a trade is being carried on.
A Jemima has just sold a house that she bought four months ago. She has spent £50,000 to make the property more attractive to potential purchasers. Jemima has not lived in this house
B Richard has sold some shares that he has owned for nine years for substantially more than the original cost
C Charlotte, a student, is experiencing cash flow problems and has had to sell a car that she bought three months ago
D Thomas has an interest in vintage cars. He has just sold a car that he has been renovating for the last six months. This is the seventh renovated car that he has sold in the last two years
A, D
What is the default method of accounts preparation for ST/Part unincorporated businesses from 2024/25?
The cash basis is the default method.
Under the cash basis, what is included in accounts?
Only cash received and paid by the business.
Are capital allowances available under the cash basis?
No, payments for capital assets (except cars and non-depreciating assets like buildings and land) are deductible, but capital allowances are not available.
How are receipts from the sale of capital assets treated under the cash basis?
They are taxable when received, except for cars and non-depreciating assets like buildings and land.
What rules apply to cars and non-depreciating assets under the cash basis?
Capital allowances can be claimed on cars, but expenditure on non-depreciating assets is disallowed.
Can GAAP (accrual basis) be used instead of the cash basis?
Yes, but only if an election is made.
Can companies and LLPs use the cash basis?
No, they are excluded from using the cash basis.
If an exam question does not specify the accounting basis, which should you assume?
Assume the cash basis unless stated otherwise.
Are taxable trading profits the same as accounting profits?
No, taxable trading profits must be adjusted in accordance with tax legislation.
Why do net profits from financial statements need adjusting?
Because certain expenses and incomes are treated differently for tax purposes.
How do you adjust net profit per accounts to determine tax-adjusted profits?
Add disallowable expenditure and income not in accounts, then deduct non-trade income in accounts and expenditure not in accounts.
What is deducted from tax-adjusted profits before final taxable profits are calculated?
Capital allowances (CAs).
What are capital allowances (CAs)?
Tax relief on certain capital expenditures that replace depreciation for tax purposes.
What is allowable expenditure?
Revenue expenditure incurred wholly and exclusively for the purposes of the trade, not specifically disallowed by legislation.
What happens to disallowable expenditure in profit calculations?
It must be added back to profits in the adjustments to profit calculation.
How does expenditure treatment differ between the cash basis and GAAP?
Some expenses are treated differently depending on whether the cash basis or GAAP is used.
How does HMRC treat dual-purpose expenditure?
HMRC allows a reasonable apportionment between business (allowable) and private (disallowable) use.
How is the cost of capital assets treated under the cash basis?
Allowable, except for cars, land, and buildings.
How are proceeds from the sale of capital assets treated under the cash basis?
Taxable as trading income, except for cars, land, and buildings. If you brought a building but it was not fit for purpose, so it was ‘repaired’ this is part of capital cost.
How is the cost of capital assets treated under GAAP?
Disallowable.
Are repairs and maintenance allowable under GAAP?
Yes, repairs and maintenance are allowable. TTP as low as possible therefore on tax side of our side of revenue ‘refurbish’, ‘repair’ is a repair not capex but rev ex.
What types of items does cap ex relate to?
Capital exp is when something was not there to begin with.
How is improvement or enhancement of assets treated under GAAP?
Disallowable, but repairs using industry-standard materials or technology may be treated as revenue expenses, even if there is an element of improvement (e.g., replacing a broken single-glazed window with a double-glazed one).
Is depreciation allowable under GAAP?
Always disallowed
How do we treat disposal of fixed assets under GAAP? 2
Disposal of fixed assets
– Loss = added back
– Profit = deduct
Are appropriations of profit allowable for tax purposes?
No, appropriations of profit are disallowable.
Is a salary paid to a sole trader or partner allowable?
No, it is disallowed. Can not be an employee of your own business. Drawings not allowable.
Is a sole trader’s income tax or NIC bill allowable if paid by the business?
No, it is disallowed.
Are private expenses put through P&L allowable?
No, they are disallowed.
Is a salary paid to a family member allowable?
Yes, but only if it is a reasonable payment for work done.
How are provisions treated under the cash basis?
No deduction is allowed for provisions, as no cash payment is made.
How are provisions treated under the GAAP basis?
Movements in general provisions are adjusted, but movements in specific provisions are not adjusted. Provision is a LIABILITY in DEAD CLIC. Therefore INCREASE is a CR so provision increases and DR Expenses.
How is an increase in provision treated under GAAP?
It is added back to profits.
How is a decrease in provision treated under GAAP?
It is deducted from profits.
How are bad debts treated under the cash basis?
No adjustment is needed for unpaid invoices, as revenue will not have been included in the accounts.
How are trade bad debts treated under GAAP?
They are allowable.
How are non-trade bad debts treated under GAAP?
They are disallowed unless they relate to loans to employees, which may be included as employment income.
What are the conditions for a non-trade bad debts to be allowable/disallowable under GAAP?
W/O loan to FORMER employee is DISALLOWED. W/O loean to CURRENT employee ALLOWED - as taxed as employment incometo do with trade.
Is staff entertaining allowable for tax purposes?
Yes, staff entertaining is allowable.
Is customer entertaining allowable for tax purposes?
No, customer entertaining is disallowed.
What types of gifts are allowable?
Gifts to employees, trade samples, and gifts to customers meeting specific conditions.
What are the conditions for customer gifts to be allowable?
They must have the business name on them, not be food, drink, tobacco, or vouchers for goods, and cost £50 or less.
Are all other types of gifts allowable?
No, all other gifts are disallowable.
Are donations to small local charities allowable?
Yes, donations to small local charities are allowable.As they may have a marketing purpose e.g. ‘event sponsored by XYZ’
Are donations to national charities allowable?
No, donations to national charities are disallowed.
Are political donations allowable?
No, political donations are disallowed. Only allowed under IHT.
Are donations of trading stock or used plant & machinery to charities or educational establishments allowable?
Yes, they are allowable.
How are donations made under Gift Aid treated?
They provide tax relief via extending tax bands and are therefore disallowed in adjustments to profit.
Are subscriptions to trade and professional associations allowable?
Yes, they are allowable. List of an actual organisaton e.g. ICAEW.
Are fines and penalties allowable for tax purposes?
No, they are disallowed.
What is the exception to the disallowance of fines?
A parking fine incurred by an employee while on business is allowable.
Is interest paid on business loans allowable?
Yes, interest on business loans is allowable.
Is interest on late payment of tax and other non-business loans allowable?
No, it is disallowed. Different rule for companies
Are trade-related legal and professional fees allowable?
Yes, they are allowable for tax purposes.
Are legal and professional fees related to dealings with HMRC allowable?
No, they are disallowed. As fees for ST/Part are perosnal
How are capital-related legal fees treated for tax purposes?
They are disallowed if they relate to disallowable items (e.g., acquiring depreciable capital assets under GAAP).
Which legal fees are specifically allowable under GAAP?
Legal fees for renewal of a short lease (50 years), registering a trade patent or copyright, and raising long-term finance.
When is irrecoverable VAT allowable?
If the expenditure it relates to is allowable.
Are employment payments allowable under GAAP?
Yes, generally, but timing rules apply.
When are earnings allowable under GAAP?
If paid within nine months of the end of the accounting period.
When are pension contributions allowable under GAAP?
In the accounting period of payment. Only on cash not GAAP basis.
How do employment payments differ under the cash basis?
The same as GAAP, but payment must be made to be deductible.
Are car leasing and rental costs allowable under the cash basis?
Yes, they are fully allowable.
Are car leasing costs allowable under GAAP?
Yes, hiring, leasing, and renting plant and equipment are allowable, but adjustments may be needed for cars.
What is the flat-rate disallowance for leasing a car with Cars CO2 > 50g/km under GAAP? NOT IN TAX TABLES
Cars CO2 > 50g/km: Flat rate disallowance = 15% × hire charge
Is there an adjustment for leasing a car with CO2 ≤ 50g/km under GAAP? NOT IN TAX TABLES
No adjustment is needed.
How is private use of a leased car with CO2 > 50g/km adjusted? NOT IN TAX TABLES
Calculate allowed amount first = 85% × hire charge × business %, then disallow the balance
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £1,000 on party for five employees
£1,000 on party for five employees - Allowable as the £150 limit applies to employment income not trading profits (NB taxable benefit for employee)
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. Gift of desk diary to ten customers with trade logo costing £35 each
Gift of desk diary to ten customers with trade logo costing £35 each - Allowable (advert, £50 or less)
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £5,000 on new roof for workshop
** £5,000 on new roof for workshop - Disallowable (capital), add back £5,000.
Cash basis – disallowed because it relates to land. Accrual basis – capital expenditure so always disallowed.
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £500 increase in general bad debt provision
£500 increase in general bad debt provision - Disallowable, add back £500.
Cash basis – disallowed because it is a provision and there has been no payment of cash. Accrual basis – disallowed because it is a general provision (not specific).
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £50 to local hospital, a registered charity, as sponsor for new scanner
£50 to local hospital, a registered charity, as sponsor for new scanner - Allowable (small, local, public image)
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £150 debt to former employee written off
£150 debt to former employee written off - Disallowable, add back £150
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £35 parking fines incurred by salesman on business
£35 parking fines incurred by salesman on business - Allowable
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £5,000 contribution into employee’s registered pension scheme
£5,000 contribution into employee’s registered pension scheme - Allowable
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. Gift of bottle of wine to twenty customers with trade logo costing £25 each
Gift of bottle of wine to twenty customers with trade logo costing £25 each - Disallowable (drink), add back £500 (20 × £25)
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £1,000 donation to the Conservative Party, a political party
£1,000 donation to the Conservative Party, a political party - Disallowable (political donation), add back £1,000
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £1,500 accountancy fees for preparing accounts
£1,500 accountancy fees for preparing accounts - Allowable
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £2,500 on redecoration of office
£2,500 on redecoration of office - Allowable (maintenance)
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £100 interest on late payment of tax
£100 interest on late payment of tax - Disallowable, add back £100
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £6,000 depreciation on capital assets
£6,000 depreciation on capital assets - Disallowable add back £6,000. Cash basis – disallowed because it isn’t cash. Accrual basis – disallowed because it is capital expenditure.
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £500 legal fees on grant of a new 25-year lease of shop
£500 legal fees on grant of a new 25-year lease of shop - Disallowable (not renewal), add back £500. Cash basis – disallowed because it is related to land. Accrual basis – disallowed because it is capital expenditure (if it had been a renewal rather than a new lease, it would have been allowed by HMRC concession as de minimis).
Classify the following expenditure as allowable or disallowable under both the cash or accrual basis and state how you would deal with it in the adjustment of profits computation. £400 contract costs for a trader’s own mobile phone. HMRC have agreed that 60% of the use of the phone relates to business.
£400 contract costs for a trader’s own mobile phone. HMRC have agreed that 60% of the use of the phone relates to business. - Disallow the private proportion (40%). HMRC have agreed that 60% Add back (40% × £400) = £160
How should goods taken for private use be treated under the cash basis?
Income must reflect a ‘just and reasonable’ amount, such as cost.
What adjustment is needed if the sole trader has already adjusted drawings at cost under the cash basis?
No adjustment is required.
What adjustment is needed if the sole trader has not adjusted drawings at cost under the cash basis?
Add in cost.
How should goods taken for private use be treated under the GAAP basis?
Income must reflect market value (selling price), not cost.
What adjustment is needed if the sole trader has already adjusted drawings at cost under the GAAP basis?
Add in profit.
What adjustment is needed if the sole trader has not adjusted drawings at cost under the GAAP basis?
Add in selling price.
INCOME is taxable or not taxable. EXPENSES are allowable or disallowable
INCOME is taxable or not taxable. EXPENSES are allowable or disallowable
How should non-trade income in accounts be treated for tax purposes?
It must be deducted from trading profits/income and moved to correct place in tax computation.
What are examples of non-trading income that must be deducted from trading profits? 3
- Rental Income (Property Income)
- Profits on the disposal of fixed assets - deduct and taxed on gain to CGT
- Investment income - deduct taxes as SI or DI
What is the most common expenditure not shown in the accounts?
Business expenditure paid personally by the owner.
Is business expenditure paid personally by the owner allowable?
Yes, it is allowable and should be deducted.
What is the trading allowance for individuals carrying on a trade?
1000
If trading receipts are less than £1,000, how is it taxed?
The trading income is not taxable.
What are the two options if trading receipts are £1,000 or more?
PICK THE BIGGER OF THE 2. 1) Trading income = receipts - £1,000 (requires a claim), or 2) Trading income = receipts - allowable expenses as normal.
What assumption should be made in the exam unless told otherwise regarding trading receipts?
If receipts are less than £1,000, they are not taxable. If receipts are £1,000 or more, no claim is made, and trading income is calculated as normal.
What are capital allowances (CAs)?
They are the tax equivalent of depreciation. Estimated expense so we DEDUCT.
On what type of assets can capital allowances be claimed?
Plant and machinery (P&M), which includes vehicles, computers, office furniture, and equipment. NOT BUILDINGS
What are some grey area items included as P&M?
Building alterations needed to install P&M and computer software licences.
If using the cash basis, which assets can capital allowances be claimed on?
Only on cars.
Who is entitled to claim capital allowances?
Sole traders, partnerships, and companies.
Are capital allowances calculated for the tax year?
No, they are calculated for the period of account, not the tax year.
What is the acquisition cost of an asset for capital allowances?
It is simply the cost of the asset.
If a sole trader or partner brings an asset they already own into the business, what value is used?
Market value (MV).
What is the disposal value for capital allowances if an asset is sold?
Sales proceeds are limited to the original cost.
What is the disposal value if an asset is given away?
Market value (MV) is used.
What types of assets are included in the main pool?
Machinery, fixtures and fittings, equipment, vans, forklift trucks, lorries, motorcycles, and cars with CO2 emissions of not more than 50g/km.
What is WDA? 3
WDA = 18% per annum
Pro rate WDA for non 12 month periods of account
The date of acquisition of the asset within the period of account is irrelevant: calculate WDAs on the last day of the period on all assets owned on that day
What is a first-year allowance (FYA)?
FYA is 100% relief for expenditure on certain assets in the period of account in which the expenditure is incurred. FYA not for first year of trading but for first year of the item.
Are first-year allowances time apportioned for short or long periods of account?
No, FYAs are never time apportioned.
What are the qualifying assets for first-year allowances?
New and unused zero-emission goods vehicles, new qualifying low-emission cars (electrically propelled or with zero emissions), and electric vehicle charging points.
How are disposals of assets that attracted first-year allowances treated?
Disposal proceeds (limited to cost) are deducted from the relevant pool.
What does the annual investment allowance (AIA) apply to?
Most plant & machinery (P&M) except cars.
What is the AIA limit per annum?
£1,000,000 per annum.
What relief do additions covered by AIA receive?
They receive 100% relief.
How is expenditure above the AIA limit treated?
The balance receives normal writing-down allowance (WDA) in the main pool.
How should AIA be allocated?
Allocate AIA to assets otherwise getting the lowest allowances; do not allocate AIA to assets qualifying for 100% FYA.
How is AIA handled for non-12-month accounting periods?
It is pro-rated for non-12-month accounting periods.
What is the WDA rule for small pools?
If the Tax Written Down Value (TWDV) after additions and disposals in the main pool is £1,000 or less, the balance can be written off as WDA instead of normal allowances.
How is the small pool limit applied for non-12 month accounting periods?
The £1,000 small pool limit is pro-rated for accounting periods that are not 12 months long.
How does the treatment of cars depend on CO2 emissions?
Cars are categorized into three groups based on CO2 emissions: Low emission (0g/km), Main pool (1-50g/km), and High emission (special rate pool).
What is the capital allowance treatment for low-emission cars?
Low emission cars (0g/km) qualify for 100% First Year Allowance (FYA).
How are cars with CO2 emissions between 1-50g/km treated?
Cars with CO2 emissions of 1-50g/km are allocated to the Main Pool, do not qualify for Annual Investment Allowance (AIA), and receive normal Writing Down Allowance (WDA) with the rest of the pool.
What happens to high-emission cars in capital allowance treatment?
High-emission cars are allocated to the Special Rate Pool and are not covered in the Principles of Taxation syllabus.
From when do the new emission thresholds apply for tax purposes in the 2025 exam?
For exams in 2025, all cars will be considered as purchased on or after 1st April 2021.
What are single asset pools?
Assets with private use by the owner of the business (sole trader or partner) are kept in separate columns.
Who can have private use assets in capital allowances computation?
Only sole traders and partners, NOT companies.
How is each asset recorded in single asset pools?
Each asset has a separate column.
How are assets written down in single asset pools?
They are written down by full allowance (FYA, AIA, or WDA).
How is business use percentage handled in single asset pools?
Only the business use percentage of the allowance is deducted.
What should the total allowances claimed on an asset equal over its life?
Its fall in value, calculated as Cost – Proceeds on disposal.
What happens if too many allowances have been claimed on a private use asset (proceeds > TWDV)?
If we have sold the item for more than it is worth in our books then we have claimed too much allowance which leaves a balancing charge which is a negative value. This reduces CA for the period (or add to adjusted trading profits), so profits are overstated So the excess must be given back as a balancing charge. To do this we add back the balancing charge in the relevant pool to net that to 0, and in our allowance column we deduct this.
How is the balancing charge for private use assets calculated?
Balancing charge x business % for private use assets
What happens if too few allowances were claimed on a private use asset (proceeds < TWDV)?
If we have sold the item for less than it is worth in our books then we have not claimed enough allowance which leaves a balancing allowance which is a positive value. This increases CA for the period (or deducted from adjusted trading profits), so profits are understated. So a balancing allowance can be claimed. To do this we deduct the balancing allowance in the relevant pool to net that to 0, and in our allowance column we add this.
How is the balancing allowance for private use assets calculated?
Balancing allowance x business % for private use assets
What happens if too many allowances are claimed in the main pool (ie, Proceeds of disposal > TWDV of the entire pool, so pool becomes negative)?
Reduces CA so more profit to pay tax on. A balancing charge is given back if proceeds of disposal exceed the tax written-down value (TWDV).
What happens if too few allowances are claimed in the main pool (ie, Proceeds of disposal < TWDV of the pool)?
THIS RULE IS DIFF IN MAIN POOL AND PRIVATE USE ASSTES. A balancing allowance can be claimed only on cessation of trade; otherwise, an 18% writing-down allowance pa continues to be claimed.
What was the basis period system used for in the past?
The basis period system was used for 2022/23 and earlier, but it is not included in the POT syllabus.
What were the transitional rules in place for 2023/24?
Transitional rules were in place for 2023/24, but they are not part of the POT syllabus.
From which tax year will the POT exam apply the new tax basis rules?
The POT exam will apply new tax basis rules starting from the 2024/25 tax year.
How should profits of an ongoing business be assessed?
Profits of an ongoing business should be assessed from 6 April to 5 April.
How should profits of a new business be assessed?
Profits of a new business should be assessed from the commencement date to 5 April.
How should profits of a business ceasing to trade be assessed?
Profits of a business ceasing to trade should be assessed from 6 April to the cessation date.
What should be done if the period of account (POA) does not correspond with the tax year?
If the period of account (POA) does not correspond with the tax year, combine profits of POA or apportion profits of a POA.
In the final tax year of a business, what period is used to assess profits?
In the final tax year, profits are assessed from 6 April to the date of cessation.
What are the late accounting date rules related to an accounting date between 31 March and 4 April?
Profits for days after the accounting period up to and including 5 April are treated as nil.
Do late accounting date rules apply in the year of cessation?
No, late accounting date rules do not apply in the year of cessation.
How are trades commencing between 1 and 5 April treated under late accounting date rules?
Trades commencing between 1 and 5 April have profits/losses of the commencement tax year treated as nil.
How are partners in a partnership taxed?
Partners are taxed individually on their share of the partnership profits, which are split according to the partnership agreement and treated as if they were sole traders.
What adjustments are made to the net profit per accounts of a partnership to determine adjusted partnership profits?
Adjustments include adding back disallowed expenses and deducting income taxed elsewhere and capital allowances.
How are partnership profits allocated among partners?
Partnership profits are shared out according to the profit-sharing agreement.
What is a ‘salary’ in the context of partnership profit allocation?
‘Salary’ refers to a special share of profit allocated to a specific partner before the remaining profits are distributed.
How is the balance of partnership profits allocated?
After allocating salaries, the remaining balance is divided based on the profit-sharing ratio (PSR).
What happens when a new partner joins a partnership during the year?
If a new partner joins, profits are shared first using the old profit-sharing agreement and then under the new agreement for the remaining period.
How is profit sharing affected when there is a change in the partnership agreement during the accounting period?
When a partnership agreement changes during the year, profits must be split between the different agreements according to the time they were in effect.
If a change in the partnership agreement occurs during the year, how should profits be shared?
Profits are shared in proportion to the number of months each agreement was in effect, with adjustments for salaries allocated first.
