F6 Taxation (UK)

Taxation (UK) Section A: The UK tax system Section B: Income tax liabilities Section C: Chargeable gains Section D: Corporation tax liabilities Section E: Inheritance tax Section F: National insurance contributions Section G: Value Added Tax Section H: The obligations of tax payers and/or their agents

Section B: Income tax liabilities B2. Income from employment B3. Income from self – employment (Part 1) B3. Income from self – employment (Part 2) B5. The comprehensive computation of taxable income and income tax liability B2. Income from employment B3. Income from self – employment (Part 1) B3. Income from self – employment (Part 2) B5. The comprehensive computation of taxable income and income tax liability Designed to give you knowledge and application of:

 Describe and apply the badges of trade. [2]  Compute the assessable profits on commencement and on cessation. [2]  Describe and apply the badges of trade. [2]  Compute the assessable profits on commencement and on cessation. [2] Learning Outcomes B3 (Part 2): Income from self employment

Describe and apply the badges of trade Where there is doubt as to whether an activity constitutes a trade Badges of trade a number of key factors have been identified through judicial decisions Subject matter / intention of transaction Length of period of ownership held Frequency of similar transaction Supplementary work & marketing Taxpayer’s intention behind sale Profit motive

The assessable profits on commencement and on cessation Basis period rules on commencement of business The first tax year Basis period runs from the date the trade commences to the following 5th April Example Annie started trading on 1 January 2011, annually preparing accounts to 31 December. She started trading in 2010 – 11. The basis period is 1 January 2011 to 5 April 2011.

Basis period rules on commencement of business The second tax year If the accounting period ending in the second tax year:  is at least or exactly 12 months long, tax the twelve months ending on that accounting date  is less than twelve months long, tax the first twelve months of trading  has no accounting period ending in the second tax year, tax the period 6th April to 5th April of the second tax year. The assessable profits on commencement and on cessation (continued) Refer to Rosy’s Example on page 73

The third tax year  If 12 months accounting ends in the third tax year, tax that period.  If (a) is not possible, tax 12 months to the accounting date in the third tax year. Subsequent tax years 12 months accounting ending in the tax year – the current year basis Profit which will be taxed more than once Overlap profit Refer to the Example (Merry) on page 75 Refer to the Example (Vicky) on page 76 Summary of basis period rules Refer to the diagram on page 75 The assessable profits on commencement and on cessation (continued)

(II) Trading income taxable but not included in the accounts Less: (I) Expenditure deductible for tax purposes but not shown in the accounts (II) Income included in the accounts but not taxable as trading income XAdjusted profit before capital allowance Add: (I) Expenditure shown in the accounts but not deductible for tax purposes XNet trading profits per accounts £Calculation of adjusted profit X X (X) Proforma Starting point

Summary of deductible expenses Continued… This denotes deductible. This denotes non deductible. 1. Appropriation of profit Tax must be paid on all profits of the business, so any appropriation in respect of drawings, owner’s salary, interest on capital, the owner’s personal income tax and NICs must be added back. 2. Salaries to family member Salary to family members in excess of market rates is not deductible. 3. Expenses attributable to private use by owner Expenses attributable to private use by owner e.g. telephone is not allowable. 4. Depreciation / amortisation The accounting rules (depreciation) are different from the prescribed tax rules (capital allowances) so depreciation is added back and capital allowances are deducted instead. 5. Provisions A specific provision, that relates to revenue expenditure, and is specifically quantifiable, is allowable. General provisions are disallowable. yes No

Continued… 6. Capital expenditure Capital expenditure is specifically disallowed. Capital expenditure is not normally charged to the income statement. However repairs and maintenance expenditure charged to the income statement may contain items that are of capital nature. Expenditure on repairs (returning the asset to its original condition) and maintenance (redecoration) is allowable. If the expenditure relates to improvement or enhances the value of the asset, it is capital expenditure, and disallowed. 7. Gifts  Gifts to employees are allowable.(but may be taxable on the employee).  Gifts to customers are not allowable unless: i.They cost not more than £50 per person per year. ii.They are not food, drink, tobacco or vouchers exchangeable for goods. iii.They carry a conspicuous advertisement for the business. yes

Continued… 8. Entertaining  Entertaining employees is allowable  Entertaining customers, suppliers or anyone else is not allowable. 9. Donations A donation to a national charity is not allowable. Similarly, donations to a political party are not allowable. However, reasonably small gifts or donations to a local charity are allowable. 10. Subscriptions Subscriptions to professional and trade associations are allowable if they relate to the trade. However, political subscriptions and donations are not allowable. 11. Legal and professional charges Allowable if they relate to revenue expenditure incurred for the purposes of trade. Allowable expenses include: a)Fees relating to an action for breach of contract. b)Fees paid to a lawyer in relation to trade debt collection. c)Fees incurred in defending title to a fixed asset. d)Fees for audit and accountancy work, and agreeing tax liabilities with HMRC. However, fees incurred in relation to tax appeals and investigations are not allowable. and No yes No yes

Continued… Legal and professional fees relating to following capital expenses are specifically allowable:  Legal costs incurred in the renewal of a short (50 years or less) lease  Incidental cost relating to the raising of long-term finance (even if the loan is not obtained)  Costs incurred relating to the registration of a patent or copyright. 12. Interest Interest, including interest on business bank overdrafts, hire purchase and credit cards is allowable. Note: interest paid as a result of the late payment of tax is disallowed. 13. Bad debts  Trade bad debts are allowable.  Employee bad debts or other non-trade loans written off are not allowable. 14. Penalties and fines Fines or penalties imposed due to infringements of the law are disallowed e.g. penalties for late registration of VAT, speeding fines of the owner, fine for infringement of health and safety regulations. An exception is parking fines incurred by employees whilst on business are allowable. No yes

Continued… 15. Staff- related expenses Staff-related expenses are deductible, and include the following:  Gross salaries and employer’s National Insurance Contributions.  Employer’s contributions into an occupational or personal pension scheme.  Redundancy payments and compensation for loss of office. If payment is made on the cessation of trade, payments up to three times the statutory amount, in addition to statutory redundancy payments are allowed (i.e. four times the statutory redundancy amount in total).  Counseling services for employees leaving employment.  Educational courses arranged for staff, if for trade purposes.  Contributions to local enterprise agencies etc. 16. Removal expenses to new business premises Allowable, provided it is not due to the expansion of the business. 17. Illegal payments Payments, which constitute a criminal offence such as a bribe or illegal payments such as payments to blackmailers or extortionists, are not allowable. 18. Irrecoverable VAT Irrecoverable VAT is allowable if it relates to an item of allowable expenditure. yes No yes

Continued… 19. Staff defalcations Losses as a result of the dishonesty of employees are allowable. However, losses resulting from the owner’s dishonesty are not allowable. 20. Traveling expenses The cost of business travel by the owner are allowable, but not travel from the home to the office. 21. Car leasing and rental costs The cost of hiring, leasing or renting car are allowable irrespective of its price. However, there is a restriction on the allowable expenditure where the CO2 emissions of the car exceed 160g/km. 15% of the leasing costs are disallowed and 85% are allowed while calculating taxable profits where the CO2 emissions of the car exceed 160g/km. yes

Refer to Example on page 69 Discussed in detail in B4 Refer to Test Yourself 3 on page 71 Refer to Self Examination Question 7 on page 86 Continued… 22.Short term lease premiums When a trader pays a short term lease premium, the deduction of the lease premium paid is allowable from their trading profits. Such a premium is deductible each year for the period of the lease. Rent premium deductible per year is calculated by using the formula: (P – 2% of (P x (n-1))) / no. of years of lease Where, P = Premium n = no. of years of lease yes

RECAP  Describe and apply the badges of trade. [2]  Compute the assessable profits on commencement and on cessation. [2]  Describe and apply the badges of trade. [2]  Compute the assessable profits on commencement and on cessation. [2]