INCOME FROM SELFEMPLOYEMENT
WEEK 4
• Trade Income
– This is profits from unincorporated trade arising from trade,
profession or are assessed as trading income.
– Profits are assessed on a current year basis [CYB]. That is to
assessment is on the profit of the twelve months account period
ending in that tax year.
• Badges of Trade
– Subject matter of the transaction [S]. are the goods of a type
normally used for trading?
– The length of Ownership [O]. Short ownership is more likely to
indicate trade
– The Frequency of similar transitions by the same person [F].
Frequent transactions indicate trade
– Supplementary work, improvements and marketing [I]. Work
performed on goods to mark them more marketable indicates
trading.
– The circumstance/reason for the sale [R]. Forced sale to raise
cash indicated not trading
– The motive [M]. Intention to profit may indicate trade.
• Adjusting the accounting Profits
– The accounting profit and the trading profits
are rarely the same figure.
Reason for adjusting profit
Adjustment required to arrive at the
tax adjusted trading profit
Expenses that are not allowable for tax
computations that have deducted from
trading profits
Add back to the accounting profit.
Taxable trading income may not be included
in the I/S
Add back to the accounting profit.
Expenses that are deductable for tax
purposes may not have been deducted in the
I/S
Deduct from accounting profit.
May include income that is not taxable as
trading income
Deduct from accounting profit.
• Pro forma
£
X
X
X
X
Net profit per accounts
Add: Expenditure not allowed for taxation purpose
Expenditure allowable for taxation purpose
Taxable trading income not credited in the accounts
Less: Expenditure not charged in the accounts but allowable for
taxation purpose
Income included in the accounts that is not taxable as trading
income
capital allowance
X
[Y]
Tax-adjusted trading profit
X
£
X
X
X
Y
Please Note: The examiner requires the answers to be in this format for
full marks to be awarded.
• Non deductable Expenditure
– Deductable if the expense is wholly and exclusively
for the purpose of the trade.
– Expenditure may be disallowable because:
• If it is too remote from the purpose of trade [remoteness test]
• If it has more than one purpose and one of them is trading
[duality principle]
– Appropriations are disallowable expenses.
• Examples include: Business owner’s salary, drawings for
sole traders or partners, and interest on owner’s capital
investment in the business.
– Salaries paid to the sole traders or their family
members is an allowable expense as long as they are
not excessive [at the market going rate].
– Interest Payable:
• On accruals basis trading interest is allowable. E.g. Over
draft charges, bank interest
• For unincorporated businesses, interest paid on overdue tax
is not allowable, like wise interest received on overpaid tax is
not taxable.
Capital Expenditure
•
Capital expenses are not allowable trading
•
•
•
•
expenses. Expenses such as Dpn, loss on sale of
non current assets, or the amortisation of a lease is
also disallowable for taxation purpose
Distinction not clear between repair and
improvement.
A initial repair to make an asset usable not
deductable Ship [seaworthy]. Deductable if the asset
can be used before the repairs [repairs to cinemaswear and tear]
Restoration costs are deductable where the
restoration is to renew a subsidiary part of the asset
and not to replace the asset [ factory chimney
replacement]
CA to be considered later
• Entertainment expenditure is a disallowable
• Gifts to employees are normally allowable [remember to
exclude those that fall under the benefits rules]
• Gifts to customers are only allowable if:
– They cost less than £50 per customer per year. if more the whole
amount is disallowed
– The gift is not food tobacco or vouchers exchangeable for goods
– It carries a small logo [advertisement] of the business making the
gift.
• Legal and professional charges [consider reason for the
cost]
– it its for the purpose of the trade it is allowable. Examples
include:
• Legal fees
• Charges incurred in defending the title to non current assets
• Expenditure of a capital in nature is disallowable [patent registration]
• Impaired debts and allowable for debtors
– Allowable
• The write of trade debt
• An allowance for trade debtors to reflect the
potential irrecoverability or impairment of debt as
long as the calculation followed UK GAAP.
– Disallowable
• Write off of non trade debt [loan to customer or
employee]
Types of Expenditure
Treatment
Notes
Provisions for future cost [e.g. provision for
future warrant cost]
Allow
Provided they are calculated following GAAP or IAS
Compensation for loss of office paid to an
employee
Allow
Only if for the benefit of trade
Counselling service for redundant employees
Allow
Defalcations [e.g. theft/fraud]
Allow
Only if by employees and not the owner/director
Educational courses
Allow
Only if for trade purposes
Fines
Disallow
Unless parking fines include on business by
employees, but not owners/directors
Payment that constitutes a criminal offence
Disallow
Pension contributions to a registered pension
scheme
Allow
Premium for insurance against an
employee’s death or illness
Allow
Redundancy pay in excess of the statutory
amount
Allow
On the cessation of trade the limit is 3 X the
statutory amount
Removal expenses
Allow
Provided not an expansionary move
Salaries accrued at the year end
Allow
Provided paid not more than 9 months after year
end
Provided paid by the year end [not accrued]
• Other Adjustments
– Taxable trading income not included in the I/S
• When a trade take goods out his business for personal use:
the trader is treated as making a sale to himself based on the
selling price of the goods concerned. This dose not apply to
the supply of services
• Accounting treatment: Add back if the trader has accounted
for the goods in the COS. the profit element needs to be
added back in the computation of the adjusted profit for
taxation purpose.
– Deductable expenditure not chargeable in the I/s
•
•
•
•
•
The most important is capital allowance
Trading element of lease premiums on short leases
Business element for use of private residence
Business calls from private telephone of sole trader
Expenses that are wholly and exclusively for the trade that
have been met from private funds of the owner
– Short lease premiums [50 years or less]
• Some of the premium is charged to income tax as
property income
• Some of the premium on a short lease is treated
as income for the landlord in the year the lease is
granted.
• The amount is calculated as; the amount of the
premium less 2% of the premium for each year of
the lease (other than the first year). Include
complete years ignore parts of the year.
• Adjustment for taxation
– Add back the amortisation charged in the I/S [capital
therefore disallowed]
– Deduct the allowable proportion of the lease premium
• Assessable income on the landlord
– P-[P x 2% x (n-1)] or P x [51-n]/50
• Income included in the I/S that is not taxable
trading income. These include
– Capital receipts: profits on sale of capital assets
– Other income [savings and dividend income] should
not be included in trading income but included in
another section of the tax computation
– Income that is exempt from tax such as interest
received on overpaid income tax
• Pre trading expenditure; any revenue
expenditure incurred in the seven years before
commencement of trade is treated as an
expense on the first day of trade.