Trading Profits Flashcards
Give a summary of how to calculate trading profits
Chargeable receipts LESS deductible expenditure LESS capital allowances = Trading profit/loss
Why is calculation of trading profits necessary?
For sole traders and partners, the first step in an income tax calculation is to work out total income and here, income from their business = trading profit
For companies, the first step in a corporation tax calculation is to calculate income profits and trading profits will form part of its income
Business can make income and capital profits (capital is like a building increasing in value)
Understanding calculation of trading profits comes first
What are ‘chargeable receipts?’
This means money received for the sale of goods and services
Receipts must derive from the business’ trade and be income (recurring) rather than capital in nature
Trade can mean ‘operations of a commercial character by which the trader provides to customers for reward some kind of goods or services.’
Capital profits like sale of shares are ignored
What is ‘deductible expenditure?’
1) This means expenditure which must be of an income nature and incurred ‘wholly and exclusively’ for the trade
- Deduction must not be prohibited by statute
2) Income in nature:
- Incurring the expenditure so that the business can sell the item at a profit (stock), means it is income in nature
- If the expenditure has the quality of recurrence (utility bills etc), it will be income in nature
- Expenditure on items to help the business to trade (office building for example), will be capital and not deductible
3) Wholly and exclusively
- Expenditure with a dual purpose doesn’t fit, like eating in a restaurant when working away from home, as they would need to eat anyway
- Some expenses can be apportioned (part of cost of heating/lighting when working from home)
What are some common examples of ‘deductible expenditure?’
Salaries
Rent on commercial premises
Utility bills
Stock
Contributions to an approved pension scheme for directors/employees
Interest payments on borrowings
What is meant by ‘capital allowances?’
Businesses are entitled to a capital allowance, which allows them to deduct a proportion of the cost of most capital items from chargeable receipts. This results in the business paying less tax overall
Main types of capital asset for which a capital allowance is permitted are plant and machinery
- Plant can include whatever apparatus business people use to carry on their business, so includes all goods and chattels which they keep for permanent use but not stock
- Manufacturing equipment, tools, computers etc
What is the ‘writing down allowance?’
Each financial year, the business is entitled to a writing down allowance of 18% of the value of the business’ plant and machinery, valued at the start of the financial year
- 18% of total value of plant and machinery will be deducted from chargeable receipts. The reduced value is known as the written down value of the asset
- All plant and machinery are generally pooled and the WDA is calculated each year on the basis of the whole pool; where an asset is sale, the proceeds of sale are deducted from the value of the whole pool
What is the ‘annual investment allowance?’
1) The annual investment allowance allows incorporated and unincorporated businesses to deduct the whole cost of plant and machinery purchased in that particular accounting period from chargeable receipts (applies to new and second hand assets)
- The amount is £1 million, so the first £1 million qualifying expenditure in an accounting period will be wholly deductible
2) Companies only can deduct 100% of qualifying expenditure to an uncapped amount, provided the assets are brand new only (full expensing)
There are various reliefs for trading losses available for unincorporated businesses. Give an overview about the general effect of these.
Where there are trading losses, reliefs allow the taxpayer to deduct a trading loss from other income, resulting in them paying less tax overall
Where they are eligible for more than one relief, they may choose which relief to claim, or they can claim relief under multiple if there are still unabsorbed losses and they are eligible
Partners decide individually which relief they wish to claim in relation to their share of the partnership’s losses
Taxpayer must apply for the relief from HMRC; none apply automatically
Explain start-up loss relief
Relief is available when the taxpayer suffers a loss in any of the first four tax years of a business
Loss can be carried back and set against their income in the three tax years prior to the year of the loss, so they claim some of the income tax they paid to HMRC back
Loss must be set against earlier years before later years – work towards the present
As it works against total income, it means the taxpayer can lose the benefit of their personal allowance
Explain carry-across/one-year carry-back relief for trading losses generally
Four options here; the losses can be
Set against total income from the same tax year
Set against total income from the tax year preceding the tax year of the loss
Set against total income from the same tax year until that income is reduced to zero, with the balance of the loss being set against total income from the tax year preceding the tax year of the loss; or
Set against total income from the tax year preceding the tax year of the loss until that income is reduced to zero, with the balance of the loss being set against total income from the tax year of the loss
As it goes against total income, it means the taxpayer loses the benefit of their personal allowance
Explain set off against capital gains, in relation to carry-across relief
Allows the taxpayer to set trading losses against chargeable gains in the same tax year and applies when a taxpayer has claimed carry-across relief, but not all of the loss has been absorbed
Explain carry-forward relief
Taxpayer can carry forward their trading loss for a tax year and set it against subsequent profits which the trade produces in subsequent years, taking earlier years earlier
Losses can be carried forward indefinitely unless the loss is exhausted
Taxpayer must inform HMRC of its intention to claim the relief no more than four years after the end of the tax year in which the loss was incurred
Explain carry-back of terminal trading loss
Any loss incurred in the final 12 months of trading can be set against trading profits in the final tax year and then carried back and set against trading profits in the three years preceding the loss, starting with the most recent year and working back until year limit is reached, or loss is absorbed
No cap to the amount which can be relieved this way
Explain carry-forward relief on incorporation of business
If a 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 their salary or dividends
To be classed as ‘wholly or mainly in return for shares’, 80% or more of the consideration for the business transferred must be shares in the company
What is the cap on start-up relief and carry-across/back relief?
They are subject to a cap of the greater of £50k or 25% of the taxpayer’s income in the tax year in relation which the relief is claimed; cap only applies to income from sources other than trade which produced the loss
Provide a summary of the types of relief, the time of loss, what the loss can be set against and for which time periods
1) Start-up relief by carry-back
- The first four tax years of trading
- Total income
- The three tax years preceding the tax year of the loss
2) Carry-across and/or carry-back one-year relief
- Any accounting year of trading
- Total income and (if this is exhausted) chargeable gains
- The tax year in which the accounting year of the loss ends and/or preceding tax year
3) Carry-forward relief
- Any accounting year of trading
- Subsequent profits of the same trade
- Any subsequent tax year until the loss is absorbed
4) Terminal relief by carry-back
- The final 12 months of trading
- Previous profits of the same trade
- The final tax year and then the three tax years preceding the final tax year
5) Carry-forward relief on incorporation
- Up to incorporation
- Subsequent income received from the company
- Any subsequent tax year until the loss has been absorbed
