Unit 2 Trading: Calculating Profits and Paying VAT Flashcards
Calculating trading profits
2 kinds of profit = income and capital.
Income profits = recurring in nature, such as rent or trading profit, whereas capital profits are one- off items, such as an office building increasing in value.
Income profits made by sole traders and partnerships form part of their total income for the purposes of income tax (or corporation tax for corporate partners).
Companies’ income profits are charged to corporation tax, as are its capital profits.
Trading profits = calculated in broadly the same way for both income tax and corporation tax, but under different statutes.
Trading profits/losses calculation
Chargeable receipts LESS deductible expenditure LESS capital allowances = trading profit/loss.
Trading profits/losses calculation - chargeable receipts
= money received for the sale of goods and services.
The receipts must derive from the business’s trade and be income (ie recurring) rather than capital in nature.
Trading profits/losses calculation - deductible expenditure
Must be of an income nature, and incurred ‘wholly and exclusively’ for the trade.
Its deduction must not be prohibited by statute.
E.g. client entertainment and leasing cars with emissions over a certain level.
Income of nature = If the reason for incurring the expenditure is so that the business can sell the item at a profit (eg, stock).
Alternatively, if the expenditure has the quality of recurrence (for example, utility bills).
Wholly and exclusively for the purposes of trade = applied strictly.
Commonly deductible:
* salaries (as long as they are not excessive given the services that the person carries out);
* rent on commercial premises;
* utility bills;
* stock;
* contributions to an approved pension scheme for directors/ employees; and
* interest payments on borrowings.
Trading profits/losses calculation - capital allowances - plant and machinery
Each financial year, the business is entitled to a writing down allowance (‘WDA’) = 18% of the value of the business’s plant and machinery, valued at the start of the financial year.
Generally pool all plant and machinery and WDA calculated on pool.
Annual investment allowance = 100% capped at £1,000,000
for companies and unincorporated businesses, new/secondhand/refurbished.
For companies only - Also full expensing 100% for brand new only.
Relief for a trading loss: unincorporated businesses - Start- up loss relief (also known as early trade losses relief)
Available if suffer a loss in any of the first four tax years of the new business.
The loss can be carried back and set against the taxpayer’s total income in the three tax years immediately prior to the tax year of the loss.
Claim must be made on or before the first anniversary of 31 January following the end of the tax year in which the loss is assessed.
Relief for a trading loss: unincorporated businesses - Carry- across/ one- year carry- back relief for trading losses generally
The losses can be:
- set against total income from the same tax year; or
- set against total income from the tax year preceding the tax year of the loss.
- set against total income from the same tax year until that income is reduced to zero, with the balance of the loss being set against total income from the tax year preceding the tax year of the loss; or
- set against total income from the tax year preceding the tax year of the loss until that income is reduced to zero, with the balance of the loss being set against total income from the tax year of the loss.
Must set loss against total income, often reducing it to zero - lose personal allowance.
Relief for a trading loss: unincorporated businesses - Set- off against capital gains
Set trading losses against chargeable gains in the same tax year, and applies when a taxpayer has claimed carry- across relief but not all of the loss has been absorbed.
Relief for a trading loss: unincorporated businesses - Carry- forward relief
Taxpayer may carry forward their trading loss for a tax year and set it against subsequent profits which the trade produces in subsequent years, taking earlier years first.
Losses can be carried forward indefinitely until the loss is exhausted.
Must notify HMRC of its intention to claim the relief no more than four years after the end of the tax year in which the loss was incurred.
A taxpayer can use all of carry- forward, carry- across and carry- back reliefs in relation to the same loss, until the loss is wiped out.
Relief for a trading loss: unincorporated businesses - Carry- back of terminal trading loss
Any loss incurred by a taxpayer in the final 12 months of trading can be carried across and set against trading profits in the final tax year, and then carried back and set against trading profit in the three years preceding the year of the loss, starting with the year preceding the year of the loss and moving back year by year until the loss is fully absorbed or the three- year limit is reached, whichever is first.
No cap on the amountAny loss incurred by a taxpayer in the final 12 months of trading can be carried across and set against trading profits in the final tax year, and then carried back and set against trading profit in the three years preceding the year of the loss, starting with the year preceding the year of the loss and moving back year by year until the loss is fully absorbed or the three- year limit is reached, whichever is first.
No cap on the amount.
Allows other sources of income which are connected to the trade but not actually profits of the trade to be treated as trading profits for the purposes of this relief.
Relief for a trading loss: unincorporated businesses - Carry- forward relief on incorporation of business
If a taxpayer incorporates their business by transferring it to a company wholly or mainly in return for shares, any trading losses which have not been relieved can be carried forward and set against any income they receive from the company, such as their salary or dividends.
Wholly or mainly in return for shares = 80% or more of the consideration for the business transferred must be shares in the company.
No cap on amount.
Relief for a trading loss: unincorporated businesses - Cap on reliefs
Start- up relief and carry- across/ carry- back relief are all subject to a cap of the greater of £50,000 or 25% of the taxpayer’s income in the tax year in relation to which the relief is claimed.
Only applies to income from sources other than the trade which produced the loss.
Value added tax (‘VAT’)
Rate = 20%
The business charges the customer VAT at 20% on the value of the goods or services, known as ‘output tax’.
The business deducts from the amount it collects in output tax any VAT it has itself paid (‘input tax’) on goods or services received, and pays the difference to HMRC.
Exempt supplies = residential land, postal services, education and health services.
Zero rated supplies = books, certain food and water. Can reclaim VAT.
Must be registered if value of taxable supplies in the preceding 12 months exceeded £85,000.
Must pay the VAT it owes within one month from the end of each quarter in respect of taxable supplies made in that quarter.
