Trading Income

Question 1

Badges of trade

Answer 1

1. Subject matter of the transaction
   -quantity and nature
   -not inherited or held for investment potential
   -Rutledge v IRC (1 million toilet rolls)
2. Frequency of transaction
   -greater frequency indicates trade
   -Pickford v Quirk (buy and resell cotton mills)
3. Circumstances responsible for realisation
   -whether planned disposal or not
   -raising money for u expected event is not regarded at trading
4. Supplementary work carried out
   -trading more likely to have taken place if work done on property to make property more marketable
   -Cape Brandy Syndicate v IRC (bought brandy intending to modify it and sell in smaller quantities)
5. Motives for the transaction
   -objective of making a profit suggests trading, although even in absence of a profit motive, it may be concluded that trading is taking place
   -Wisdom v Chamberlain (intention of making a profit from the sale of the button)
6. Length of ownership
   -shorter period indicates trade
   -considered weakest of tests

Question 2

HMRX will also consider

Answer 2

1. source of finance to fund activity
   -working capital v long term loan
   -long term generally denotes investment rather than trading
2. Circumstances of acquisition
   -bought v inherited
3. Relation to other activities carried out (property investment v development)

Question 3

Basis of assessment

Answer 3

-> standard part = first 12 months of 23/24 basis period
-> transition part = remainder

is split because can result in very long basis period assessed for a 12 month year.

To mitigate this
-> all overlap profits bf must be used in 23/24 to reduce tax liability
-> taxable profits arising in the transition part is automatically spread over five years starting in 23/24

Question 4

Late accounting date rules

Answer 4

To avoid appointments of profits that result in only a few days of profits being included in the transition part, there are a few late accounting date rules
1. Accounting date between 31 march and 4 April, the profits or losses for the period from the accounting date to 5 April will be treated as arising in the following tax year
2. Special rules apply for businesses that commence or cease trading between 1 April and 5 April

Question 5

Taxable income

Answer 5

1. Income receipts v capital receipts
   -income = taxed as trading income
   -capital = taxed as capital gain
   -consider
   -> does receipt relate to non current asset (capital) or current asset of business (income)
   -> fruit and tree method = tree is enduring part (capital) and fruit is recurring part (income)
   -> what is paid for
2. Voluntary payments
   -payment for some personal quality of receiver are not income
   -> Murray v Goodhews
   -acceptance of lower fee in expectation of further work can be income
   -> McGowan v Brown
3. Goods taken for private use
   -must be accounted for at market value not cost or reduced value
   -> sharks v wemher
   -> if can show for genuine commercial purpose then no adjustment
   -> applies to traders only

Question 6

Allowable expenditure

Answer 6

Must satisfy three criteria
1. Incurred ‘wholly and exclusively’ for purpose of the trade
2. Must be revenue item, not a capital expense
3. Must not be specifically disallowed by statue

Question 7

1. Wholly and exclusively

Answer 7

Doesn’t beee to be necessarily unlike employment.

Remoteness test
-> must be related to day to day activities of business
-> no political donations, trade subscriptions okay

Duality test
-> if expense has dual purpose then not allowed
-> mallalieu v Drummond (barristers black clothes not allowed)

Question 8

2. Revenue v capital

Answer 8

-normal accounting rules
-recurring nature indicates revenue expenditure
-enduring benefits = does expense bring into existence something that has endured benefit for the trade (capital)
-repairs allowed but improvements not
-renovations not but replacements allowed

Question 9

Allowable expenditure- other

Answer 9

1. Self education of owner
   -expand v update knowledge (new skill is capital)
   -staff education permissible
2. Staff secondments
   -salary expenses allowed
3. Lease premiums
4. Losses from devaluations
   -staff theft
   -if recoverable under insurance not allowable
   -not allowed defalcations by senior staff
5. Pre trading expense
   -treated as incurred on first day if incurred in seven years before trading
6. Post trading expenses
   -relief for expenses for remedial work or legal fees for up to seven years after cessation
7. Timing
   -payment to employees must be made within nine months of year end or tax deduction deferred until period in which paid
   -pension contributions
   -> period in which paid
   -> spread if unusual increase

Question 10

Specifically disallowed items by statue

Answer 10

1. Fines and parking
   -parking fines of employment
2. Entertainment
   -customer/supplier disallowed
   -staff allowed but under £150 per head
3. Gifts
   -local charities allowed (benefits reputation of business)
   -to others
   -> less than £50
   -> container conspicuous advertisement for the business
   -> not food, drink, or tobacco
4. Leased cars
   -> based on CO2 emission.
   -> if >50g/km then only 85% of the lease costs are allowable (disallow 15%). Doesn’t count if leased for 45 days or less
5. Redundancy costs
   -> allowable if wholly and exclusively for business purposes
6. Appropriations of profit and provisions disallowed
   -> drawings
   -> depreciation
   -> general provisions for doubtful debts (not bad debts written off)
   -> stock provisions (allowances)

Question 11

What are capital allowances

Answer 11

-> not deductible when computing trading income, but certain capital expenditure qualifies for tax relief in a form of standardised tax depreciation (capital allowances)

Why given
-to ensure acquisition acquisition of and investment in capital assets
-to ensure consistent treatment (unlike deprecataitiopn)

How given
-an allowance to set off against trading profits
-> reduce profits and therefore tax charge
-> flexibility of claiming good tax planning opportunities

What given on
-directed at certain types of assets to avoid abuse
-evidence of business investing in non productive assets just to obtain tax relief

When given
-when obligation to purchase becomes unconditional

Question 12

Assets that qualify for capital allowances

Answer 12

-plant and machinery (including integral features)
-buildings

Question 13

Plant

Answer 13

-asset perform active function in the carrying out of the business if yes qualifies for capital allowances

Question 14

Integral features

Answer 14

-> need to be separately identified from plant and machinery because they qualify for a different rate of CA. They are items attached to buildings including:
1. Electrical systems
2. Cold water systems
3. Water heating systems
4. Lifts, escalators, moving walkways

-> special rate pool

Question 15

Main pool

Answer 15

-> allowances calculated in a reducing balance basis
-> WDA @ 18%

1. Plant, machinery, vans, motor cycles, lorries
2. Cars with CO2 emissions of up to 50g/km
3. Cars with higher emissions are dealt with in special rate pool
4. Cars of zero or low emissions are eligible for 100% first year allowances and do not join any pool

Question 16

Special rate pool

Answer 16

-> WDA @ 6%

1. Cars with CO2 emissions exceeding 50g/km
2. Certain integral features
3. Thermal insulation on buildings
4. Long life assets (expected life of more than 25 years but only if business spends more than £100,000 a year on such assets)

Question 17

Small pools

Answer 17

-> if balance of pool is less than £1,000 can claim whole balance

-> IMPORTANT = WDA is per annum so allowances scaled if less than 12 months

Question 18

Annual investment allowances (AIA)

Answer 18

• designed to stimulate investment in new capital
• available for individuals and companies engaged in qualifying trades
• allows businesses of any size to claim each year an allowance of
  -> 100% of the first £1m of expenditure since 1 jan 19
  -any excess expenditure eligible for WDA
  -if related to business only AIA available

Question 19

First year allowance (FYA)

Answer 19

-green assets
-Enhanced capital allowances (ECA)
-relief given at 100%

1. Zero/low emission cars
2. Plant for refilling of certain vehicles (gas, biogas, H2)
3. Water conservation equipment

Question 20

Balancing charges and allowances on pools

Answer 20

1. If proceeds greater than original cost, original cost is substituted in the computation
2. If asset disposed of and proceeds exceed balance on pool, balancing charge may result
3. If proceeds less than balance on pool, cannot claim balancing allowance on pool, unless due to cessation of trade

Question 21

Separately pooled assets

Answer 21

-> assets with some private use
1. Used by proprietor only, not staff
2. AIA or FYA
3. Assets where there is partly private use by the owner (car) are dealt with
4. Only business proportion can be claimed
5. Employee partly private assets taxed as BIK on employee not employer
-> short life assets
1. Not cars
2. Balancing allowance available if sold within 8 years following year acquired
3. If not sold, rejoins main pools
4. Do not make election if AIA available (get immediate relief)

Question 22

Basis period up to 22-23

Answer 22

-> tax the accounts with y/e falling in the tax year (normal 12 months)
-> current year basis

Question 23

Overlap profits

Answer 23

Same profits taxed twice under old rules as follows
1. On commencement of trading, depending on date of commencement and the accounting reference date
2. If a trader changed the accounting reference date for drawing up accounts

-> relief given on cessation of trade which could be many years later

Question 24

Self assessment tax return (payment of income tax)

Answer 24

-taxpayer is legally responsible for submitting a return of income and paying any tax due
-must inform HMRC within 6 months of tax year end of new sources of income in that year or receive penalty

For individuals with more complicated affairs
-main return
-supplementary pages

Simplified return
-not directors
-not higher rate taxpayers
-particularly designed for pensioners

-> paper 31st oct following end of tax year
-> online 31 Jan following end of tax year

Question 25

Late submission of return (IMPORTANT)

Answer 25

If 3 months late = £100
Over 3 months late = then £10 per day (£900 max)
Over 6 months late = then add greater of £300 or 5% of tax liability
Over 12 months late = add greater of £300 or 5% of tax liability (can be 70% if deliberate withheld or 100% if deliberate and concealed)

Question 26

Paying taxes

Answer 26

Indirect methods
-PAYE on wages and salaries
-deduction at source

Direct method (direct assessment)
-based on tax calculation and reported on the self assessment tax return

Question 27

Direct method

Answer 27

Three payments for any year
- 31 Jan in tax year (1st payment on account)
- 31 July after tax year (2nd payment on account)
- 31 Jan after tax year (final payment)

Payments on account = each payment is 50% of relevant amount

No POA if
- < £1,000
- > 80% paid indirectly
- first year

POA can be reduced if taxpayer expected liability to be lower/nil

Question 28

Late payment penalties (IMPORTANT)

Answer 28

1. If all or part of final balancing payment remains unpaid more than 30 days after the due date a penalty charged equal of the amount underpaid
2. Is this amount still unpaid after another 5 months another 5% is imposed
3. Another 6 months another 5% penalty

Interest for POA
-runs from due date to date of actual payments
-daily date

Question 29

Other penalties (IMPORTANT)

Answer 29

1. Failure to notify changeability or submission of incorrect tax return
   -deliberate and concealed 100%
   -deliberate but not concealed 70%
   -otherwise 30%
   -reduced if taxpayer informs HMRC to 20% or 0%
2. Fraudulent or negligent reduction of POA
   -penalty equal to difference between POA paid and POA due
3. For failure to keep required records
   -£3,000 for each year
4. HMRC can mitigate penalties if taxpayer co operates

Question 30

business ethics

Answer 30

Concerns
1. Expectations of society
2. Fair competition
3. Advertising
4. Social responsibility
4. Corporate behaviour

-how individuals interact with each other
-how organisations relate to external stakeholders and the community as a whole

Question 31

Professional ethics

Answer 31

-apply
1. Principle based approach
2. Based on fundamental principles
-to ensure clients are offered the best possible service
-to protect the public at large
-to protect and enhance the reputation of the profession with the public and with the business community

Question 32

Fundamental principles of professional ethics

Answer 32

1. Integrity = straightforward and honest
2. Objectivity = no prejudice, bias or influence of others
3. Competence = professional ability, technical legal and regulatory requiremnets
4. Due care = reasonable dispatch
5. Confidentiality = not use or disclose info without clients permission
6. Professional behaviour = bear reputation in mind

Question 33

Losses

Answer 33

1. Loss in standard part, profit in transition part
   -loss in standard part is deducted from profit in transition part
   -remaining transition profit is taxed in equal instalments in 23/24 to 27/28
2. Loss in transition part (after overlap deduction)
   -loss is aggregated with profit or loss in the standard part
   -if overall there is a profit that profit is assessed in 23/24
   -if overall there is a loss, the amount assessed in 23/24 is zero

Question 34

Offset against total income of the same year or the previous year

Answer 34

• can choose to claim to set losses against total income of loss making year and the prior year, even if trade was not carried out in earlier year
• any remaining losses are automatically carried forward
• losses set off against total income in any order to achieve the lowest tax liability
  -> sideways relief

Use against
-total income of current year
-total income of previous year
-both of these

-claim must be made by 31 Jan
-cannot make partial claims (may loose some personal allowance)
-if claim two lots of losses against same total income the current years losses take priority (restricting carry back period)
-> s64

Question 35

Carry forward for offset against future profits of the same trade

Answer 35

-must be same trade profits
-used against first available profits
-do not have to include capital allowance in the loss calc which results in a larger writing down value carried forward and increased allowances available in the future

Problems
-delays relief
-no control over amount of relief
-if tax rates falling, may get relief at lower rates

-> claim to carry forward trading losses under s83 must be made within four years of the end of the tax year in which the loss arises

Question 36

Early year losses relief

Answer 36

If incurred in first four years of trading
-can carry forward as normal
-relive against total income of pervious three years, beginning with earliest (FIFO)
-result in repayment of tax paid
-total loss must be relived which could result in loss of personal allowances
-21 months to claim relief
-s72

Question 37

Cessation reliefs

Answer 37

1. Terminal loss relief s89 ITA 2007 = loss arising in the last 12 months old trading
2. Transfer of a snugness to a limited company s86 ITA = the transfer to a company is a cessation of trade for the trader or partnership

Question 38

Terminal loss relief (s89)

Answer 38

Incurred in the last 12 months.
-can be set against trading profits in which cessation occurs and previous three years
1. Loss from 06/04 to cessation plus
2. Loss from period 12 months before cessation to following 05/04 plus
3. Overlap profits bf
-> if 1 or 2 is a profit it is included as zero
- relief given in Agee years first
-cannot claim partial relief

Can get post cessation relief (incurred up to 7 year) on
-remedying defective work and legal/insurance costs
-bad debts and collection costs
-> if income insufficient can claim relief against capital gains

Relieving the terminal loss
1. In the tax year in which the cessation occurs
2. Previous three tax years
3. Relief is given in later years first
4. Maximum relief must be given in each year (no partial claims)

Question 39

Relief losses when trade transferred to a company (IMPORTANT)

Answer 39

If traded transfers business to a limited company
-there is a cessation of trade by the trader
-trade changes in ownership

s86 provides some relief if conditions are met
-consideration for the business received by the trader is wholly or mainly (80%+) in shared in the company
-the shares are held by the transfer throughout the period that any s86 claim is made
-company continues to carry on the same business
-transferor may set unreceived losses against the first available income that they receive from the company

Question 40

Partnerships

Answer 40

1. Partnership exists where two or more individuals trade together
2. Not separate legal entity or tax. Profits and losses are allocated between partners and each partner is then taxed individually

Question 41

Partnership taxation (IMPORTANT)

Answer 41

-must submit a tax return to HMRC each year but the partnership itself is not regarded as a separate entity for tax purposes
-instead each parted is taxed individually on their share of partnership profit
-each partner is solely responsible for the tax due on their partnership profit
-the trading profit for a period of account is split between partners in accordance with their profit sharing agreement for that period
-if the profit sharing agreement changes during a period the profit is time apportioned applying the old agreement to the pre change profit and the new agreement to the post change profit

Question 42

Changes in partnership composition

Answer 42

-when a new partner is admitted to a partnership, that partner is assessed under the commencement rules but the existing partners continue to be assessed on the current year basis
-when a partner leaves a partnership that partnership is assessed under the cessation rules but the remaining partners continue to be assessed on the current year

Question 43

Trading losses for partnerships

Answer 43

-each partner can claim tax relief on their share of a partnership trading loss in the same way as a sole trader
-each partner might choose a different form of loss relief
-there are restrictions on the amount of sideways relief that can be claimed by a limited partner or non active partner

Question 44

Notional profits and losses (IMPORTANT)

Answer 44

1. These arise because partners are allocated salaries or interest on capital before applying the profit sharing ratio
2. This can result in the individual partner being allocated a loss when the overall partnership result was a profit or vice versa
3. If a notional loss arises, that partner share of profit is adjusted to £nil
4. The notional loss is allocated amongst the other partners in proportion to their profit sharing ratios

Question 45

Short lifed assets (IMPORTANT)

Answer 45

-> a trader may elect that an asset (other than a car) which would normally join the main pool should instead be treated as a short life asset
-> if the de-pooling election is made then the asset is treated on an individual basis and therefore
1. If asset not disposed of within 8 years it is transferred into main pool
2. If it is disposed of within 8 years, a balancing allowance will be given

Question 46

Two main reliefs (IMPORTANT)

Answer 46

1. Trading loss may be carried forward and set against future total profits (subject to limits). This relief takes effect if no other tax relief is claimed in relation to a trading loss
2. Claim to set loss against total profits of the company of
   -> the accounting period in which the loss arises
   -> if claimed the 12 months prior to the accounting period in which the loss arises
3. Trading loss incurred in 12 months before a company ceases to carry on that trade (terminal loss) may be set against the company’s total profits for the proceeding three years later