Trading Profits and Losses

Question 1

Why does a business need to calculate its profits?

Answer 1

For tax purposes

Question 2

Are there separate methodologies to work out profits and losses for incorporated and incorporated businesses?

Answer 2

No, the same methodology for companies and unincorporated businesses is used

Question 3

What are the types of profit?

Answer 3

Income profit - recurring in nature i.e. rent, trading profit

Capital profit - profit from one off item i.e. increase in office building value

Question 4

Give an overview of the calculation to workout trading profits and losses

Answer 4

1. Add together chargeable receipts
2. Minus deductible expenditure
3. Minus capital allowances

Question 5

What are chargeable receipts?

Answer 5

Money received for the sale of goods and services. In other words, income profits not capital profits

Question 5

What form must a deductible expenditure take?

Answer 5

Deductible expenditure must be of income nature and incurred wholly and exclusively for trade

Question 6

What does income nature mean?

Answer 6

Income nature = expenditure that is incurred so that the business can sell the item at a profit (i.e. stock) or it is recurring (i.e. utility bills)

Question 7

Explain ‘wholly and exclusively for trade’

Answer 7

Strict application of ‘wholly and exclusively for trade’ i.e. if someone was eating at a restaurant this would not be deductible because they would have needed to eat anyway

However, if something is dual purpose i.e. the cost of heating when WFH, this can be deductible

Question 8

What are common examples of deductible expenditure?

Answer 8

o salaries (as long as they are not excessive given the services that the person carries out);
o rent on commercial premises;
o utility bills;
o stock;
o contributions to an approved pension scheme for directors/employees; and
o interest payments on borrowings.

Question 9

What deductible expenditure is forbidden under statute?

Answer 9

client entertainment and leasing cars with certain emissions levels

Question 10

What are the capital allowances?

Answer 10

o Annual investment allowance
o Full expensing
o Writing down allowance

Question 11

What are the main types of capital item?

Answer 11

plant and machinery, this includes:
o whatever apparatus business people use to carry on their business
o all goods and chattels which are kept for permanent use but not stock in trade.
o manufacturing equipment
o tools
o computers and other office equipment.

Question 12

What are capital allowances?

Answer 12

Generally, capital assets cannot be deducted from chargeable receipts because they are not income in nature. However, to encourage investment, capital allowances on certain assets can be deducted from chargeable receipts which has the effect of reducing the tax payable.

Question 13

What is the annual investment allowance? How does this work?

Answer 13

This is applicable to newly acquired assets. The asset can be new, second hand or refurbished, but it must have been recently acquired by the business.

The whole cost (capped at £1m) of capital asset(s) bought in that accounting period can be deducted from chargeable receipts.

If the cost of the assets is more than £1m, then the surplus is subject to writing down allowance (assuming full expensing doesn’t apply)

Question 14

What is the annual investment allowance in relation to groups of companies?

Answer 14

A group of companies will only receive one AIA for the group

Question 15

What is full expensing? How does this work?

Answer 15

This applies brand new assets and companies only.

A company can deduct 100% of the cost of a brand new capital assets (no cap) purchased in a particular account period.

If the company sells the asset, the company would need to apply a balancing charge for the disposal value (i.e. they sell for £10k, they need to increase their taxable profits by £10k)

Question 15

What is the writing down allowance? How does this work?

Answer 15

This applies to old capital assets.

1. Calculate the total value of the plant and machinery at the beginning of that accounting period
2. Calculate 18% of the total - this figure is deducted from the chargeable receipts
3. The written-down value of the asset is the total value minus 18%, this is the figure used in subsequent years

Example:
i. Capital asset = £100k
ii. Year 1: 18% of £100k = £18k WDA which is deducted from the chargeable receipts. Written-down value of asset = £82k.
iii. Year 2: 18% of £82k = £14,760 WDA which is deducted from the chargeable receipts. New written-down value of asset = £67,240
iv. Year 3: 18% of £67,240 = £12,104 WDA which is deducted from the chargeable receipts. New written-down value of asset = £55,136

Question 16

How do trading loss reliefs work in relation to partnerships?

Answer 16

each partner decides which relief they want to opt for

Question 17

What are trading loss reliefs? How can they be used?

Answer 17

Trading loss reliefs can be used to offset a loss against other taxable income (and sometimes CGT) in either the same or a different tax year to reduce the amount of IT / CGT payable

If the taxpayer is eligible for more than one type of relief, they can choose which relief to opt for. They can use a second relief if there are still unabsorbed losses after applying the first relief

Question 18

How are trading loss reliefs applied?

Answer 18

The taxpayer must apply to HMRC for the relief, they are not automatic

Question 19

What is meant by cap on reliefs and what is the cap?

Answer 19

This means that the total amount of certain tax reliefs that can be used to reduce taxable income is limited to the higher of:
o £50k; or
o 25% of the taxpayer’s income in the tax year in which the relief is claimed

In other words, if the taxpayer is using more than one tax relief, the cap applies to all of the reliefs they are seeking to apply to that tax year

This is applicable to each tax year (i.e. they can get up to £50k one year, £50k the next year etc)

Question 19

What are the trading loss reliefs?

Answer 19

1. start-up loss relief
2. carry-across and carry-back relief
3. set-off against capital gains
4. carry-forward relief
5. carry-back of terminal trading loss
6. carry-forward relief on incorporation of the business

Question 20

When is start-up loss relief available? Give an example when it would be useful to apply

Answer 20

This is available when a taxpayer suffers a loss in any of the first four years of starting a new business

it would be helpful where someone started a new business but had received income from a former business or employment

Question 20

What does the cap on reliefs not apply to?

Answer 20

The cap does not apply to income from trade. It only applies to income from other sources (i.e. income from a rental property)

Question 20

How is start-up loss relief applied? Give an example

Answer 20

The loss can be set against the taxpayer’s total income three years immediately prior to the loss

The loss is set against the income from the earliest year first. Each year must absorb as much of the loss as possible, if there is remaining loss then this can be set off the subsequent year(s).

The tax payer would then get a tax rebate for the years the loss was set against.

Example:
o 2020/2021 - pre-business. Income from salary.
o 2021/2022 - pre-business. Income from salary.
o 2022/2023 - business starts.
o 2024/2025 - business makes a loss
o The loss made in 2024/2025 can be set off against income from income in 20/21, 21/22 & 22/23 in that order.

Question 21

What is the drawback of start-up loss relief and carry-across & carry-back relief?

Answer 21

The drawback is that where the set off (against the current and/or previous years) reduces the income to £0, they will lose the benefit of the personal allowance

Question 22

When must a claim for start-up loss relief be made by? Give an example

Answer 22

The claim for this relief must be made within 1 year of 31 January following the tax year the loss was made

i.e. if you make a loss in 2024/2025, you must claim by 31 January 2027

(easy way to quickly consider this, it will be 31 Jan 2 years after the end of the tax year i.e. 2024/2025 - + 2 = 31 Jan 2027)

Question 23

Which trading loss reliefs are subject to a cap?

Answer 23

1. start-up loss relief
2. carry-across and carry-back relief
3. set-off against capital gains

Question 24

What is the other name for carry-across and carry-back relief?

Answer 24

Trade Loss Relief against general income’

Question 25

When must a claim for carry-across and carry-back relief be made by?

Answer 25

The claim for this relief must be made within 1 year of 31 January following the tax year the loss was made

Question 26

Explain carry-across relief

Answer 26

the loss can be set off against the total income in the same tax year the loss was incurred

Question 27

Explain carry-back relief

Answer 27

the loss can be set off against the total income in the tax year before the loss was incurred

Question 28

How can carry-across and carry-back relief be used?

Answer 28

The taxpayer can use carry-across or carry-back relief on their own, or they can use them at the same time. Essentially there are four options:
o Carry-across relief
o Carry-back relief
o Carry-across relief + carry-back relief
o Carry-back relief + carry-across relief

Whatever option the taxpayer chooses, they will still pay the same amount of tax.

Question 29

When can set-off against capital gains relief be used?

Answer 29

If the taxpayer has used carry-across relief, and there are still unabsorbed losses, the taxpayer can set the remaining loss off against chargeable gains made in the same tax year

(Chargeable gain = profitable change in the price of an asset)

Question 30

How is carry-forward relief applied?

Answer 30

If the loss is carried forward, this means the loss will be deducted from future profits the business makes in subsequent tax years

The loss cannot be set against future income, it is profits only

It must be applied against the earliest years first, but the losses can be carried forward indefinitely until the loss is exhausted. This is good because if a few years go by and the business does not make a profit, this is not a bar to the relief.

Question 31

What is the advantage of carry-forward relief?

Answer 31

The taxpayer will retain their personal allowance

Question 32

When must a claim for carry forward relief be made by?

Answer 32

the taxpayer must inform HMR of its intention to use this relief within 4 years of the tax year of loss

Question 33

When would carry-back of terminal trading loss be used?

Answer 33

This is relevant where a business has permanently ceased trading and they have made a loss in the final 12 months of trading

Question 34

How is carry-back of terminal trading loss applied?

Answer 34

Loss is first off-set against trading profits for the final tax year, remaining losses are then set against trading profits for the previous 3 tax years, starting with the previous year and working backwards

If there is insufficient trading profits to absorb losses in a tax year, the legislation allows other income connected to trade (i.e. dividends, interest, certain expenditure) to count as trading profit for the purposes of this relief

Question 35

When must a claim for set-off against capital gains relief be made by?

Answer 35

The claim for this relief must be made within 1 year of 31 January following the tax year the loss was made

Question 36

When is carry-forward relief on incorporation of a business relevant?

Answer 36

This is relevant where a UIB has unrelieved losses and incorporates a business by transferring it to a company in exchange wholly or mainly for shares

Question 37

How is carry-forward relief on incorporation of the business applied?

Answer 37

The taxpayer can then carry forward the losses and set these off against any income they receive from the company i.e. their salary or dividends

They can also choose the order to set off the losses and will choose the most tax-advantageous

Losses can be carried forward indefinitely

Question 38

When must a claim for carry-back of terminal trading loss relief be made by?

Answer 38

the taxpayer must inform HMR of its intention to use this relief within 4 years of the tax year of loss

Question 39

When must a claim for carry-forward relief on incorporation of the business be made by?

Answer 39

the taxpayer must inform HMR of its intention to use this relief within 4 years of the tax year of loss