Trading: Calculating Profits and Paying VAT

Question 1

What are the two types of profit businesses make?

Answer 1

Income and capital.

Question 2

How are trading profits calculated?

Answer 2

By subtracting deductible expenditure and capital allowances from chargeable receipts.

The formula is:

Chargeable receipts LESS deductible expenditure LESS capital allowances = trading profit/ loss.

Question 3

Define chargeable receipts.

Answer 3

Money received on the sale of goods/ services.

The receipts must derive from the business’s trade and be income (ie recurring) rather than capital in nature.

Question 4

How is income profit generally differentiated from capital profit?

Answer 4

General principle is that income profit is when a business buys something to sell on at a profit. If they sell something which has been used in trade, it will be classed as capital profit.

Question 5

Define income in nature.

Answer 5

Expenditure incurred so the business can sell the item at a profit. also where the expenditure has the quality of reoccurrence (eg utility bills), this would be income in nature.

Question 6

How are each of the following taxed:

a) Sole traders;
b) General Partnerships;
c) LLPs;
d) Private Limited Companies;
e) Public Limited Companies

Answer 6

a) Income tax;
b) Income tax;
c) LLPs not taxable as an entity (members pay income tax on their share of the profits).
d) Corporation tax
e) Corporation tax

Question 7

Define deductible expenditure.

Answer 7

Must be of an income nature and incurred wholly and exclusively for the trade. the deduction must not be prohibited by statute (eg client entertainment and leasing of cars with high emissions).

Question 8

Give examples of things commonly deemed deductible expenditure (incurred wholly and exclusively for the purposes of the trade).

Answer 8

• salaries;
• rent on commercial properties;
• utility bills;
• stock ;
• contributions to approved pensions schemes for employees;
• interest payments on borrowings

Question 9

Define capital allowances.

Answer 9

Businesses are entitled to a capital allowance, allowing them to deduct a proportion of capital expenditure from chargeable receipts. The main type of capital asset permitted for these purposes is plant and machinery.

Question 10

Define plant and machinery.

Answer 10

Goods and chattels kept by a business for permanent use, but not stock in trade.

Examples include manufacturing equipment, tools, PCs etc.

Question 11

Explain the writing down allowance (WDA) process.

Answer 11

Plant and machinery will be valued at the start of each financial year. 18% of its total value will be deducted from chargeable receipts when calculating trading profits or that accounting period.

Question 12

Explain the Annual Investment Allowance (AIA).

Answer 12

AIA allows businesses to deduct whole cost of expenditure of [plant and machinery from their shareable receipts. The total deductible amount currently sits at £1,000,000 meaning that the first 1 million spent on plant and machinery is wholly deductible.

Question 13

How does AIA apply to group companies?

Answer 13

The AIA allowance applies to the whole group (ie each company does not get an AIA allowance). The group can allocate this as it sees fit, but the amount will be £1,000,000 for the whole group.

Question 14

What is full expensing?

Answer 14

allows companies to deduct 100% of the cost of plant and machinery (purchased in that accounting period) from its chargeable receipts. This amount is uncapped but only applies to brand new assets.

Question 15

Can companies claim both AIA and full expunging allowances?

Answer 15

Yes.

Full expensing allowance will apply to brand new assets and the AIA will be used for second hand/ refurbished assets.

Question 16

Which business mediums are entitled to:

a) AIA;
b) Full expensing

Answer 16

a) both companies and aunicorpated businesses;
b) companies only (only applies to brand new assets).

Question 17

Explain key principles of start-up loss relief (aka early trade loss relief).

Answer 17

• Available if taxpayer suffers a loss in any of the four tax years of a new business.
• Loss can be carried back against the taxpayers total income in the three tax years immediately prior to tax year of the loss.
• Taxpayer can therefore claim back from HMRC some income tax paid in previous business/ employment;
• The loss must be set against earlier years before later years;
• Claim for the relief must be made on or before the first anniversary of `Jan 31st following end of the tac years in which the loss was assessed.

Question 18

Define carry-across/ one-year carry back relief for trading losses.

Answer 18

Where trading losses in an accounting period are treated as losses of the tax year in which the accounting period ends.

Question 19

List the four available options for the carry-across relief.

Answer 19

1) set against total income from the same tax year;
2) set against total income from the tax year preceding the tax year of the loss;
3) set against total income from same tax year until that income is reduced to 0, with the balance of the loss being set against total income from the tax year preceding thew tac year of the loss;
4) set against Toal income from the tax year preceding the tac year of the loss until that income is reduced to 0, with the balance of the loss being set against total income from the tax year of the loss.

Question 20

Explain set-off against capital gains tax relief.

Answer 20

Taxpayer can set trading losses against chargeable gains in same tax year, and applied when they have claimed carry-across relief but this has not absorbed the total losses.

Question 21

Explain carry-forward tax relief.

Answer 21

Taxpayer can carry forward trading loss for a tax year and set against subsequent profits which trade produces in subsequent years, taking earlier years first. these losses can be carried forward indefinitely until the loss is exhausted.

Question 22

Is there a time limit on claiming carry-forward tax relief?

Answer 22

Yes. Taxpayer should notify HMRC of their intention to claim the relief no more Ethan four years after the end of the tax year in which the loss was incurred.

Question 23

Explain carry-back of terminal trading loss.

Answer 23

Loss incurred by taxpayer in final 12 months of trading can be carried across and set against trading profits in final year of tax, and then carried back and set against trading profit in the three years preceding the year of the loss.

Question 24

Define VAT.

Answer 24

• VAT is charged every time a business supplied goods and services.
• Current rate is 20%.
• Business deducts form amount it collects in output tax, anything Vat it has paid on the goods or services received. The difference is then paid to HMRC.

Question 25

What are commonly VAT exempt supplies?

Answer 25

Supplies of:
- Residential Land;
- Postal Services;
- Education;
- Health Services.

Question 26

What is the statutory definition of VAT (Value Added Tax Act 1994)?

Answer 26

The tax ‘charged on any supply of goods or services made in the United Kingdom where it is a taxable supply made by a taxable person in the course or furtherance of any business carried on by him’

Question 27

Define a taxable person.

Answer 27

Person must be registered for VAT purposes if they intend to make, or makes taxable supplies, if in the preceding 12 months the value of their taxable supplies exceeded £85,000.

Question 28

Define course of business.

Answer 28

Any trade profession or vocation (note that a supply in the course of business includes the disposal of a business or any of its assets).

Question 29

What is the value of supply for the purposes of VAT?

Answer 29

The value of the supply of the goods/services without the added VAT (ie price before VAT).

Question 30

What is the difference between exempt supplies and zero rated supplies?

Answer 30

A taxable person making zero rated supplies (eg books, certain foods and water) can reclaim the VAT they have paid from HMRC. A person making only exempt supplies cannot register to pay VAT and therefore will not be able to claim any VAT.

Question 31

Why do some taxable persons (eg businesses) making less than 85k opt to register for VAT with HMRC?

Answer 31

This allows them to claim input VAT paid. IF one is not registered they cannot claim input VAT.

Question 32

Explain the allowances available to a company where their new plant and machine purchases exceed the £1 million AIA allowance.

Answer 32

The excess is subject to the 18% WDA (in addition to the 18% WDA applied to existing plant and machinery).

For example:
1) Say a company spends £1.3 million on new plant and machinery and has existing plant and machinery valued at £600k.

2) The AIA allowance will apply to the new plant and machinery cost. This means £1million is deductible straight away. Of the remaining £300k, this will be subject to the 18% (ie 18% of the remaining £300k will be deductible as capital). this means a further £54k is deductible.

3) In addition, the £600k of existing plant and machinery is subject to the WDA of 18%. 18% of 600k is 108k so a further 108k is deductible.

4) As such, the £1million AIA is deductible as well as the 54k (being 18% of the 300k over the AIA allowance) and the £108k (18% of the £600k existing plant and machinery value.