Business Taxation

Question 1

What is Business Taxation

Answer 1

It’s taxes that businesses need to pay on their earnings

Question 2

Who is subject to business taxation under UK Income Tax rules

Answer 2

Sole traders (self-employed individuals) and partnerships.

Not limited companies (they pay Corporation Tax).

Around 10% of the UK workforce falls under these rules.

Taxable profit = Net profit (accounts) + Disallowed expenses – Capital allowances.

Question 3

What is changing about the basis period for business taxation in 2024-25

Answer 3

Current rule: Businesses can use any accounting period (e.g., 31 December).

New rule (2024-25): Must align with the tax year (6 April – 5 April).

Part of Making Tax Digital (MTD) to simplify reporting.

Example: A business with a 31 December year-end must report profits from 1 Jan 2024 – 5 Apr 2025 for the 2024-25 tax year.

Question 4

How does HMRC distinguish between a trade and a hobby for tax purposes

Answer 4

They use the Badge if Trade to identify what classes as a trade.

Trade: Profits taxed as Income Tax (20%-45% + National Insurance).

Hobby: Gains may be Capital Gains Tax (CGT) (10%-28%, with £3,000 annual exemption in 2024-25).

Key question: Is the activity systematic, frequent, and profit-driven?

Question 5

What are the 6 Badges of Trade (SFLMPC)

Answer 5

Subject Matter

Frequency of Transaction

Length of Ownership

Supplementary Work & Marketing

Profit Motive

Circumstances of Sale

Question 6

Badge of Trade - Subject Matter

Answer 6

Trading likely: Goods typically bought/sold for profit (e.g., toilet rolls, branded items).

Case: Rutledge v IRC (1929) – Buying 1 million toilet rolls was trading.

Not trading: Investments (stocks, property held long-term) or personal-use items (e.g., a painting hung at home).

Question 7

Badge of Trade - Frequency of Transactions

Answer 7

High frequency (e.g., selling 100 cars/year) = Strong indicator of trade.

One-off sales (e.g., selling an inherited watch) = Likely not trading.

Example: A car dealer selling 50 vehicles a year is clearly trading.

Question 8

Badge of Trade - Length of Ownership

Answer 8

Short-term (quick resale) → Suggests trading (e.g., property flipping).

Long-term (years) → Suggests investment (e.g., holding stocks for dividends).

Question 9

Badge of Trade - Supplementary Work and Marketing

Answer 9

Adding value (e.g., repairing cars, blending products) indicates trade.

Case: Cape Brandy Syndicate (1927) – Blending and marketing brandy = trading.

Passive ownership (e.g., holding stocks) = Not trading.

Question 10

Badge of Trade - Profit Motive

Answer 10

Key factor but not definitive (hobbyists may also seek profit).

Trade likely: Systematic purchases aimed at resale (e.g., bulk-buying phones to sell online).

Hobby likely: Occasional sales (e.g., selling homemade crafts).

Question 11

Badge of Trade - Circumstances of Sale

Answer 11

Acquired accidentally (inheritance) or sold in emergency → Not trading.

Planned purchases for resale (e.g., auction buys to flip) → Trading.

Question 12

Is selling items on eBay considered trading?

Answer 12

Depends on frequency, profit motive, and effort.

Trading: Regular sales, bulk purchases, marketing (e.g., reselling sneakers).

Hobby: Occasional sales of personal items (e.g., old clothes).

Question 13

How does HMRC decide borderline cases?

Answer 13

No strict formula – examines all badges collectively.

Self-assessment: Taxpayer must justify their position.

Disclose if unsure to avoid penalties.

Question 14

What steps can taxpayers take to justify hobby vs trade status?

Answer 14

Document intent (e.g., notes on purchases).

Limit frequency if claiming hobby status.

Seek professional advice for ambiguous cases (e.g., Airbnb rentals).

Question 15

What is Taxable Income

Answer 15

Income that HMRC taxes after deducting your personal allowances and other relief

Question 16

What is the starting point for calculating taxable trading profits

Answer 16

Net profit per accounts (prepared under accounting rules).

For 2023/24, accounts can be drawn up for any period (not necessarily aligned with the tax year).

From 2024/25, all taxpayers must use a 5 April year-end (basis period reform).

Question 17

What are the two key questions when determining taxable profits

Answer 17

What income/expenses are relevant? (Adjustments needed).

Which accounts to use for the tax year? (Called the basis period for assessment).

2024/25 change: All taxpayers must use a 5 April year-end (no more misaligned accounting periods).

Question 18

Why must accounting profits be adjusted for tax purposes

Answer 18

Accounting rules ≠ Tax rules.

Adjustments ensure only taxable income and allowable expenses are included.

Examples:

Add back disallowed expenses (e.g., client entertainment).

Deduct capital allowances (tax-approved depreciation).

Question 19

Are all accounting policies acceptable for tax purposes

Answer 19

Most are OK, but some are disallowed:

Anticipated losses (e.g., losses on long-term contracts cannot be deducted in advance).

Provisions not meeting tax rules (e.g., doubtful debts must be specific, not general).

Question 20

What income adjustments are needed for taxable profits

Answer 20

Goods taken for own use: Add selling price to profit (treated as if sold to the taxpayer).

Exclude non-trading income:

Income taxed elsewhere (e.g., rent = property income).

Capital receipts (e.g., proceeds from selling a business asset).

Question 21

What are Deductible (Allowable) Expenses?

Answer 21

Expenses allowed for both accounting and tax purposes.

No adjustment needed (already reduce taxable profit).

Examples:

Wages, rent, utilities, stock purchases.

Capital allowances (replacing accounting depreciation).

Question 22

What are Non-Deductible (Disallowable) Expenses

Answer 22

Expenses allowed in accounts but not for tax.

Added back to accounting profit to calculate taxable profit.

Examples:

Client entertainment.

Depreciation (replaced by capital allowances).

Fines/penalties (e.g., HMRC penalties).

Question 23

How are Goods taken for personal use treated in tax calculations?

Answer 23

Added to profit at selling price (as if sold to the owner).

Example: A baker takes bread home worth £100 → add £100 to taxable profit.

Question 24

Capital vs Revenue Income
How are capital receipts (e.g. selling a business van) treated?

Answer 24

Excluded from trading profits.

Taxed under Capital Gains Tax (CGT) if a gain arises.

Example: Selling a delivery van for £10,000 (original cost £8,000) → £2,000 gain reported under CGT.

Question 25

What are the steps to Adjusting Accounting Profit for Tax

Answer 25

Start with net profit per accounts. Add back disallowed expenses (e.g., depreciation, entertaining). Deduct non-trading income (e.g., rent, capital receipts). Add omitted trading income (e.g., goods for own use). Apply capital allowances (tax-approved depreciation).

Question 26

What are the 3 Main Criteria for Deductible Expenses

Answer 26

MUST BE: Wholly and exclusively for trade (no private purpose) Revenue (not capital) nature Not specifically disallowed by statute

Question 27

What's the 'Wholly and Exclusive' test, how does it affect duality

Answer 27

Expense must have no private purpose (e.g., business-only mobile phone = allowable). Duality test: If mixed use (e.g., car for business & private trips), either: Apportion (business % allowed), or Fully disallowed if private use is significant. Example: 70% business mileage → 70% of costs deductible.

Question 28

How does the 'fruit and trees' test distinguish Revenue vs Capital Expenses?

Answer 28

Revenue (fruit): Day-to-day running costs (e.g., repairs, wages) → deductible. Capital (trees): Long-term assets/improvements (e.g., buying machinery) → not deductible (may qualify for capital allowances). Example: Replacing a broken window = repair (revenue). Installing new windows = improvement (capital).

Question 29

5 Specifically Disallowed Expenses by Statute

Answer 29

Depreciation (use capital allowances instead). Client entertaining (staff entertaining = allowable). Fines/penalties (e.g., parking fines, except employee fines). Proprietor’s salary (treated as profit appropriation). Gifts to customers (>£50/year or no business branding).

Question 30

Why is Depreciation added back, how is it replaced?

Answer 30

Depreciation (accounting) ≠ Capital allowances (tax). Add back £7,400 depreciation → Deduct £8,000 capital allowances (example). Key point: Only HMRC-approved capital allowances reduce taxable profit.

Question 31

Repairs vs Improvement When is a repair deductible, when is it a disallowed improvement

Answer 31

Repair: Restores asset to original condition (e.g., fixing a leak) → deductible. Improvement: Enhances asset (e.g., upgrading to energy-efficient windows) → capital. Case law: Law Shipping: Initial repairs to make asset usable = capital. Odeon Theatres: Repairs after usable = revenue.

Question 32

When are Legal Fees Deductible

Answer 32

Allowable: Debt collection, trade disputes, accounting fees. Disallowed: Capital items (e.g., drafting lease agreements). Example: Legal fees for new lease → added back (capital).

Question 33

How are car leasing costs treated for high emission vehicles

Answer 33

CO2 emissions > 50g/km: 15% of leasing cost disallowed. Example: £10,000 lease → £1,500 added back to profit.

Question 34

Is Staff Training always Deductible

Answer 34

Allowed: Update courses, skill maintenance. Disallowed: Proprietor’s new skill development (e.g., accountant taking a coding course).

Question 35

When are Customer Gifts Deductible

Answer 35

Allowed if: Cost < £50/year per customer, and Clearly advertises business (e.g., branded pens). Disallowed: Luxury gifts (e.g., £100 gift cards).

Question 36

Are Patent Royalties Deductible as Trading Expenses?

Answer 36

No → Treated as "charges on income" (deducted after profit calculation).

Question 37

What is the Cash Basis, and why might a small business choose it

Answer 37

Definition: Recognizes income/expenses only when cash changes hands (no receivables/payables). Eligibility: Turnover < £150,000 (designed for micro-businesses and sole traders). Pros: Simpler for businesses with minimal inventory or credit transactions (e.g., freelancers, small retailers). Avoids complex accounting for unpaid invoices. Cons: £500 cap on loan interest deductions (e.g., a business loan’s interest beyond £500 is disallowed). Distorts profitability for businesses with significant credit sales/purchases. Example: A plumber invoices £5,000 in March but receives payment in April. Under cash basis, this is 2024/25 income.

Question 38

How does the accruals basis reflect economic reality, and when is it required?

Answer 38

It records income when earned (invoice issued) and expenses when incurred (bill received), regardless of cash flow. Required for: Businesses exceeding £150,000 turnover. Limited companies (must use accruals under Companies Act). Advantages: Matches income to related expenses (e.g., sales revenue vs. cost of goods sold). Complies with GAAP (Generally Accepted Accounting Principles). Tax Impact: Anticipated losses (e.g., a contract penalty expected next year) are disallowed – only actual losses count. Example: A bakery buys flour on credit in December 2023 (used for orders delivered that month). Under accruals, the expense is 2023/24, even if paid in 2024.

Question 39

How does Current Year Basis determine tax years, and what are common pitfalls

Answer 39

Rule: Profits are taxed in the tax year (6 April – 5 April) where the accounting period ends. Key Scenarios: Year-end 31 December 2023: Falls in 2023/24 tax year (since 31 Dec 2023 is between 6 Apr 2023 and 5 Apr 2024). Year-end 30 April 2024: Falls in 2024/25 tax year. Pitfalls: Misalignment can cause overlap profits (taxed twice in early years) or gaps (e.g., when closing a business). Example: A consultancy with a 30 June year-end reports profits for: 1 July 2022 – 30 June 2023 → 2023/24 tax year.

Question 40

What's changing in 2024/25, and how will it affect businesses?

Answer 40

New Rule: All businesses must report profits aligned with the tax year (5 April year-end). Transition Year (2023/24): Businesses with non-5 April year-ends will report >12 months of profits (e.g., 1 Jan 2023 – 5 Apr 2024 for a 31 Dec year-end). Spread excess profits over 5 years to ease tax burden. Impact: Simplifies MTD compliance but may cause cash flow issues (higher taxable profits in transition year). Example: A café with a 31 March year-end: 2023/24: Profits from 1 Apr 2023 – 5 Apr 2024 (12 months + 5 days). 2024/25 onward: 6 Apr – 5 Apr reporting.

Question 41

Cash vs Accrual - Tax Timing Differences How does the choice of basis affect tax payments?

Answer 41

Cash Basis: Delays tax on unpaid invoices (e.g., £10,000 billed but not yet received = no tax until payment). Risk: Large cash receipts in one year can spike tax liability. Accruals Basis: Tax due on invoices issued, even if unpaid (e.g., bad debts require manual adjustment). Benefit: Smoother profit reporting for growing businesses. Example: A graphic designer: Cash basis: £8,000 project (completed Dec 2023, paid Jan 2024) = 2024/25 income. Accruals basis: Same project = 2023/24 income.

Question 42

Exceptions to Current Year Balance How are the first and last years of trading taxed differently

Answer 42

Opening Years: Year 1: Taxed on profits from start date to following 5 April. Year 2: Often creates "overlap profits" (some profits taxed twice). Closing Year: Taxed on profits from last 6 April to cessation date. Example: A business starts 1 Oct 2023 and ends 30 Sep 2025: 2023/24: 1 Oct 2023 – 5 Apr 2024 (6 months). 2025/26: 6 Apr 2025 – 30 Sep 2025 (final 6 months).

Question 43

Why is loan interest restricted under cash basis, how does it work?

Answer 43

£500 Annual Cap: Aimed at preventing manipulation (e.g., loading expenses into cash basis periods). Accruals Basis: No cap if interest is wholly and exclusively for trade. Example: A cash basis business pays £1,200 loan interest in 2024/25: £500 deductible → £700 disallowed.

Question 44

Why has the cash basis not been widely adopted?

Answer 44

Complexity in tracking cash flows vs. invoices. Restrictions (e.g., loan interest cap, turnover limit). Accruals better reflects true profitability.

Question 45

Why does HMRC prefer Accruals for large business over £150K turnover

Answer 45

Prevents manipulation: Cash basis could defer income (e.g., delaying invoices to reduce tax). GAAP Compliance: Required for audited accounts. Matching Principle: Ensures revenue and costs are recorded in the same period (e.g., sales and inventory costs).

Question 46

How does cash basis treat a £2K roof repair paid in instalments

Answer 46

Cash Basis: Deducts only the amount paid in the tax year (e.g., £500 paid in 2023/24 = £500 deduction). Accruals Basis: Deducts full £2,000 when work is completed (if incurred in the period).

Question 47

What constitutes UK Property Income, how is it taxed?

Answer 47

Rents, lease premiums (<50 years), rights of way, sporting rights, caravan/houseboat lettings. Tax Treatment: All properties pooled into a single "Property Income Business" (one profit/loss calculation). Unearned income: Not pensionable, taxed separately from trading income. Basis: Accruals (default) or cash basis (if small income). Adjustments: Similar to trading income (e.g., "wholly & exclusively" rule), but: No capital allowances – use renewals basis for capital items (e.g., replacing furniture). Example: Rental income of £8,000 is excluded from trading profits and taxed separately.

Question 48

Deductible Expenses for Property Income What Expenses can Landlords Deduct from Rental Income?

Answer 48

Allowed: Mortgage interest (restricted to basic-rate tax relief). Repairs (but not improvements). Letting agent fees, insurance, ground rent. Renewals basis: Cost of replacing furnishings (e.g., new sofa). Disallowed: Capital expenditures (e.g., property extensions). Personal use portions (e.g., if you live in the property part-time). Key Rule: Expenses must be "wholly and exclusively" for the property business.

Question 49

Furnished Holiday Lettings (FHL) Why are they treated differently from other properties

Answer 49

Treated as trading income (not property income), so eligible for: Capital allowances (on furniture, equipment). Pension contributions (tax relief). CGT reliefs: Entrepreneurs’ Relief, Rollover Relief. Loss Relief: FHL losses can offset future FHL profits (unlike other property losses). EEA Properties: Treated as separate; losses can’t offset UK FHL profits.

Question 50

What are the 4 conditions a property must meet to qualify as FHL

Answer 50

Commercial intent: Must aim to make a profit. Availability: Let for >210 days/year. Occupancy: Actually let for >105 days/year. No long-term tenants: No single let >31 days (unless exceptional circumstances). Example: A seaside cottage rented weekly in summer = likely FHL. A 6-month lease to a student = not FHL.

Question 51

How does the Rent a Room Scheme work, who benefits

Answer 51

Tax-Free Allowance: £7,500/year (per property, not per tenant). Applies to: Furnished rooms in your main home. Taxable Excess: If rent > £7,500, choose: Method A: Pay tax on profit (rent – allowable expenses). Method B: Pay tax on rent above £7,500 (no expenses deducted). Planning Tip: Parents renting to university students often use this. Example: Rent £10,000, expenses £2,000: Method A: Tax on £10,000 – £2,000 = £8,000 (only £500 taxed after allowance). Method B: Tax on £10,000 – £7,500 = £2,500.

Question 52

When should a landlord choose Method A or B for Rent a Room

Answer 52

Method A (profit – expenses): Better if expenses > £7,500. Method B (rent – £7,500): Simpler if expenses are minimal. Example: Rent £9,000, expenses £500: Method A: Tax on £9,000 – £500 = £8,500 (£1,000 taxable). Method B: Tax on £9,000 – £7,500 = £1,500 (worse here).

Question 53

How are EEA (European Economic Area) FHLs treated?

Answer 53

Separate Property Business: UK and EEA FHLs can’t pool profits/losses. Same Criteria: Must meet UK FHL availability/occupancy tests. Example: A French holiday let’s losses can’t offset UK FHL profits.

Question 54

What adjustment are made to property income for tax

Answer 54

Add: Disallowed expenses (e.g., personal use). Deduct: Allowable expenses (e.g., repairs, agent fees). Exclude: Capital receipts (e.g., selling a property). Note: Mortgage principal repayments are not deductible (only interest).