5 Income from self-employment

Question 1

How are profits assessed in a tax year?

Answer 1

The twelve month period of account ending in that tax year.

Question 2

What is the statutory definition of trade?

Answer 2

Trade includes any venture in the nature of trade

Question 3

What are the badges of trade? (SOFIRM)

Answer 3

1. The subject matter of the transaction (S).
2. The length of the period of ownership (O).
3. The frequency of similar transactions by the same person (F).
4. Supplementary work, improvements and marketing (I).
5. The circumstances/reason for the sale (R).
6. The motive (M).

Question 4

What are HMRC’s interpretation of the badges of trade? (FAST)

Answer 4

1. Finance (F)
   – where the taxpayer took out a loan to buy the asset which they expect to repay from the proceeds of sale
2. Method of acquisition (A)
   – where the taxpayer acquired the asset by way of purchase rather than receiving it as a gift or by inheritance.
3. Existence of similar trading transactions (ST)
   – where the transactions are similar to those of an existing trade carried on by the taxpayer

Question 5

What are the three reasons which an asset has been acquired?

Answer 5

1. An investment – capital in nature and not subject to income tax
2. Goods for private use of the individual (or family) – not subject to tax
3. Trade inventory – a trading transaction and subject to income tax.

Question 6

To be considered an investment what does an asset need to be doing?

Answer 6

Income producing or liable to be held for aesthetic reason

Question 7

What is the profit called after adjustments?

Answer 7

Tax adjusted trading profit

Question 8

What are the four types of adjustments that need to be made to profit?

Answer 8

1. Expenditure which tax law prevents from being an allowable deduction may be charged in the statement of profit or loss
2. Taxable trading income may not be included in the statement of profit or loss
3. Expenditure that is deductible for tax purposes may not be charged in the statement of profit or loss
4. Income may be included in the statement of profit or loss that is not taxable as trading income

Question 9

How do you determine if a expense is allowable?

Answer 9

Expenditure incurred wholly and exclusively for the purposes of the trade is allowable.

Question 10

Why may expenditure be disallowed? (2)

Answer 10

1. It is too remote from the purposes of the trade – the remoteness test
2. It has more than one purpose and one of them is not trading – the duality principle.

Question 11

What is the remoteness test?

Answer 11

Expenditure is regarded as being too remote from the trade when it is incurred in some capacity other than that of trading.

Question 12

What is the duality principle?

Answer 12

Where expenditure has been incurred for both trading and non-trading purposes, a deduction can be claimed for the business use proportion, provided it can be separately identified. This is particularly relevant to expenditure on motor cars, where business and private mileage can be identified.

Question 13

What are appropriations?

Answer 13

Appropriations are the withdrawal of funds from a business (i.e. profit extraction rather than expenses incurred in earning them) and, as such, are disallowed expenses.

Question 14

What are three examples of appropriations?

Answer 14

1. Interest paid to the owner on capital invested in the business.
2. Salary/drawings taken by a sole trader or partner.
3. Any private element of expenditure relating to the owner’s motor car, telephone etc.

Question 15

How are excessive salaries to family members treated?

Answer 15

These should be disallowable and charged at commercial rate

Question 16

In terms of capital expenditure, what expenses are disallowable?

Answer 16

Any expense in the form of depreciation, loss on sale of non-current assets or the amortisation of a lease is also disallowed.

Question 17

What expenses are allowable in terms of car leasing?

Answer 17

1. Rental and lease charges payable in respect of leased motor cars are allowable where the CO2 emissions of the car are 130 g/km or less.
2. Where CO2 emissions exceed 130 g/km, 15% of the rental/lease charges are disallowed.

Question 18

What three tests must a charity donation meet before being allowable?

Answer 18

1. Wholly and exclusively for trading purposes (for example, promoting the business name)
2. Local and reasonable in size in relation to the business making the donation, and
3. Made to a registered charity.

Question 19

If a charity donation is disallowable, how can a person claim this?

Answer 19

Through gift aid relief

Question 20

What type of subscriptions are disallowable?

Answer 20

Subscriptions and donations to political parties are disallowed.

Question 21

What is the only exception to claiming entertaining expenditure?

Answer 21

Expenditure relating to employees, provided it is not incidental to the entertainment of others.

Question 22

How are gifts to employees treated?

Answer 22

Allowable for the employer, but as the gift may fall within the benefit rules and be assessed on the employee as employment income.

Question 23

What is the rules for gifting customers?

Answer 23

1Less than £50 per year, and is not food, drink, tobacco or vouchers exchangable for goods and the gift carries an advertisement from the business

Question 24

If a gift to a customer exceeds £50, how is this treated?

Answer 24

Whole item is disallowable

Question 25

What are examples of allowable legal expenses? (5)

Answer 25

1. Debt chasing fees
2. Charges incurred in defending the title to non-current assets.
3. Fees and other costs of obtaining long-term debt finance are allowable for a sole trader.
4. The cost of registering patents is allowable.
5. The expense of renewing a short lease (i.e. less than 50 years) is allowable, although the legal expenses incurred on the initial granting of the lease are not.

Question 26

What is an examples of disallowable legal expenses?

Answer 26

Fees associated with acquiring new non-current assets.

Question 27

How is private goods taken from the business treated?

Answer 27

Add back selling price.

Question 28

What items can you deduct from taxable profit? (5)

Answer 28

1. Capital allowances
2. Use of home
3. Allowable trading element of lease premiums paid on short leases.
4. Business calls on private expenses
5. Expenses paid privately.

Question 29

How is short term premiums calculated in taxable profit calculation?

Answer 29

1. Add back amortisation

2. Allowable proportion of the lease premium

Question 30

How far back can you claim pre trading expenses?

Answer 30

Any revenue expenditure, incurred in the seven years before a business commences to trade, is treated as an expense on the day that the business starts trading.

Question 31

What is cash basis?

Answer 31

On the basis of cash received and expenses paid in the period of account), rather than the normal accruals basis provided they are under the VAT registration threshold

Question 32

Who is the cash basis option not available to?

Answer 32

1. Companies

2. LLP

Question 33

When do you have to leave the cash basis regime?

Answer 33

When the income exceeds £166,000

Question 34

How is capital and revenue expenditure treated?

Answer 34

There is no distinction between capital and revenue expenditure in respect of plant, machinery and equipment for tax purposes, therefore:
– purchases are allowable deductions when paid for, and
– proceeds are treated as taxable cash receipts when an asset is sold
– capital allowances remain available for expenditure on cars only; the capital cost is not an allowable deduction when paid

Question 35

What are the key advantages of cash basis?

Answer 35

1. Simpler accounting requirements as there is no need to account for receivables, payables and inventory
2. Profit is not accounted for and taxed until it is realised and therefore cash is available to pay the associated tax liability.

Question 36

What is the main disadvantage of cash basis?

Answer 36

Losses can only be carried forward to set against future trading profits, whereas under the accruals basis many more options for loss relief are available

Question 37

Who can claim the flat rate deductions?

Answer 37

Any unincorporated business whether they use the cash basis scheme or not

Question 38

What is the flat rate expense for motoring expenses?

Answer 38

Milage rates

Question 39

What is the flat rate expense for private use of a commercial building?

Answer 39

Private use adjustment re household goods and services, rent, food and utilities
= fixed amount
based on the number of occupants

Note that the private element of other expenses (e.g. mortgage interest and rates) must be adjusted for as normal