Trading: calculating profits and VAT

Question 1

Calculating trading profits

Answer 1

1. Income profits: recurring in nature (e.g. rent or trading profits)
2. Capital profits: one off items (e.g. building increase in value)
3. Trading profits are calculated in broadly the same way for both income tax and corporation tax

Question 2

Accounting period

Answer 2

Business must prepare accounts for accounting period of usually 12 months.

Chargeable receipts LESS deductible expenditure LESS capital allowance = trading profit/loss

Question 3

Chargeable receipts

Answer 3

1. means money received for sale of goods and services
2. receipts must derive from business trade and must be income (not capital).
   3.** Trade**: means operations of commercial character by which trader provides to customers for reward some kind of goods or services
3. Income vs capital: e.g. if business buys sth to sell on at a profit, proceed of sale will be income. if business sell sth it has used in its trade (office premises) and make a profit, it will be classed as capital profit.

Question 4

Deductible expenditure

Answer 4

1. Must be of income nature and incurred wholly and exclusively for the trade
2. its deduction must not be prohibited by statute. E.g. client entertainment and leasing cars with emission over certain level

Question 5

What is income in nature?

Answer 5

1. Reason for incurring expenditure is so that business can sell item at a profit (e.g. stock) it is income in nature.
2. Expenditure has quality of recurrence (e.g. utility bill) will be income in nature
3. Expenditure on items to help business to trade e.g. office building will be capital in nature and will not be deductible

Question 6

What does “wholly and exclusively for purpose of trade” mean?

Answer 6

1. Case law: e.g. eating in restaurant working away from home was not seen as an expense “wholly and exclusively” for purpose of trade, because person must it anyway.
2. Despit this principle, HMRC allows some expenses to be apportioned so that part is deductible: e.g. if tax payer works from home, part of cost of heating and lighting will be deductible for tax purposes.
3. Common deductible:
   a. salaries (as long as not excessive)
   b. rent on commercial premises
   c.utility bills;
   d. stock
   e, contributions to an approved pension scheme for directors employees;
   f. interest payment on borrowings

Question 7

Capital allowances

Answer 7

1. Such as plant and machinery are not income in nature but expensive and decrease in value.
2. Business are entiteld to capital allowances which allows them to deduct a proportion of cost of most capital items from chargeable receipts

Question 8

What is plant and machinery?

Answer 8

1. Case law: whatever apparatus business used to carry on business, includes all goods and chattels which people keep for permanent use in business: e.g. manufacturing equipment, tools, computers and office equipment.
2. Each year, business is entited to a writing down allowance (WDA), which is 18% of the businees plant and machinery valued at the start of financial year. Each financial year, plant and machinery will be valued, and 18% will be deducted from chargeable receipts when calculating trading profits,
3. Pooling: all plant and machinery is generally pooled, and WDA calculated each year on the basis of value of whole pool. If an asset is sold, the proceeds of slae are deducted from the value of whole pool.

Question 9

Annual Investment allowance

Answer 9

1. Businesse are allowed to an annual investment allowance AIA.
2. Full expensing: companies are entited to 100% allowance uncapped of brand new assets
3. AIA: both companies and unincorporated entitled to 100% allowance capped at GBP 1 million (until 31March24). Conditions: new, secondhand and refurbished
4. Super deduction for covide: contract signed after 3 March 21, expenditure incurred between 1 April 21 to 31 March 23: 130% without cap (ended 1 April 23).

Question 10

Relief for trading loss : unincorporated business

Answer 10

1. Tax payer must apply for relief (not applied automatic by HMRC)
2. Types of relief:
   * Start up loss relief (early trade losses relief)
   * Carry-across/one year carry back relief for trading losses generally
   * Set off against capital gains
   * Carry forward relief
   * Carry back of terminal trading loss
   * carry forward relief on incorporation of business

Question 11

Start up loss relief

Answer 11

1. relief available when a taxpayer suffers a loss in any of 1st 4 years of new business.
2. loss can be carried back and set against the tax payer’s total income in the 3 tax years immediately prior to tax year of the loss (useful if sb start a new business but had income from former business or employment)
3. claim must be made on or before 1st anniversary of 31 Jan following the end of tax year in which loss is assessed

Question 12

Carry-accross or one year carry bacl relief for trading losses

Answer 12

Trading losses in an accounting period may be relief in 4 options:
1. set against total incomr from same tax year; or
2. set agains total income of preceeding tax year
3. set against total income from same tax year until such income reduced to 0, with balance being set against total income from tax year preceding the tax year of loss; or
4. set against total income of preceding tax year until income =0, balance set against total income from tax year of loss.
5. Time to claim: on or before 1 anniversary of 31 Jan following the end of tax year which losses are assessed.

Question 13

Set off against capital gains

Answer 13

1. Set trading losses against chargeable gains in the same tax year.
2. Applies when a taxpayer has calim carry across relief but not all of loss has been absorbed.

Question 14

Carry forward relief

Answer 14

A tax payer can carry forward their trading loss for a tax year and set it against subsequent profits which business produces in subsequent years (can be indefinitely until the loss is exhausted)
Taxpayer must notify the HMRC of its intention to claim the relief no more than 4 years after the end of rtax year in which the loss incurred.
A tax payer can use all of carry forward, carry across, and carry back relief in relation to same loss, until loss is wiped out

Question 15

Disadvantage of using start up, carry across and carry back relief? advantage of carry forward

Answer 15

1. Tax payer will lose benefit of her personal allowance (GBP 12,570) in the tax years where total income reduced to 0 because losses must be set against total income.
2. Carry forward relief will be used against her business profits (not her total income) so she will retain benefit of her personal allowance.

Question 16

Carry back of terminal trading loss

Answer 16

1. Any loss incurred in 12 months of trading can be carried across and set against trading profits in the final tax year, then carried back and set against trading profits in 3 years proceeding of loss.
2. No cap on the amount can be relieved
3. how can a loss be set against profit in the same year? because rules allo other source of income which are connected to trade but not actually profits to be treated as trading profits for purpose of this relief.
4. Can only be applied to trading income

Question 17

Carry forward relief on incorporation of business

Answer 17

1. Taxpayer incorporates their business by transferring it to a company wholly or mainly in return for shares, any trading losses which have not been relieved can be carried forward and set against any income they receive from the company such as salary or dividends.
2. To be wholly or mainly in return for shares: 80% or more of consideration for the business transferred must be shares in the company.
3. Taxpayer can choose to set the loss against these types of income in the order of their choice
4. No cap of relief.
5. Must notify HMRC of its intention to claim relief no more than 4 years atfer the end of tax year in which the loss was incurred.

Question 18

Cap on reliefs

Answer 18

1. Start up relief and carry across/ carry back relief are subject to a cap of greater of GBP 50k or 25% of the taxpayer’s income in the tax year in relation to which relief is claimed
2. Cap does not usually have significant impact because only apply to income from source other than the trade which produces the loss

Question 19

VAT

Answer 19

1. VAT charged every time a business supplies goods or services. VAT is charged on any supply of goods or services made in UK where it is a taxable supply made by a taxable person in the course or furtherance of any business carried on by him.
2. Current flat rate 20%
3. business charge customer VAT at 20% on value of goods and service, output tax.
4. Business deducts from amount it collects in** output tax** any VAT it itself paid (input tax) on goods or services received and pays the difference to HMRC
5. VAT does not cost business anything. consumer takes the burden

Question 20

Exempt supplies and zero rated

Answer 20

1. Exempt supplies : e.g. residential land, postal services. education and health services
2. 0% : books and certain food and water
3. Person who makes zero rates supplies can reclaim the VAAAAAAAT they have paid from HMRC. Person ho makes exempt supplies cannot register and reclaim VAT.

Question 21

Taxable person and VAT registration

Answer 21

1. Taxable person is a person who makes or intends to make taxable supplies and who is or is required to be registered under the VAT 1994.
2. Anyonel making taxable supplies of mor e than GBP 85k in any 12 month must register and charge VAT. Those make less can choose to register.
3. Only those registered for VAT can reclaim input tax they have paid, sometimes business voluntarily register in order reclaim input tax.
4. Partnership can register for VAT in partnership name
5. HMRC will issue each person registering a VAT number which applies to all business operated by that person.

Question 22

Tax invoice

Answer 22

Person making a taxable supply to taxable person must provide a tax invoice, showing information such as VAT number, value of supply and rate of tax charged.