Sole trader and partnership tax

• Trading Income• Application to partners• VAT• Stamp Duty

Trading IncomeSee Introduction to Tax Ch 5

• Income Tax (Trading and Other Income) Act 2005

• Profits of trade, profession or vocation

• Paid by self-employed persons - sole traders and partners

Tax paid on the profits of the business

• Profit figure taken from the business accounts,

• See the profit and loss account pg 20

Profit and loss account

• Sales 10,000• Less cost of sales (6,000)• =gross profit 4,000

• Less expenses (2,500)• =Net profit 1,500

Trading Income

• Only receipts of an income nature are subject to income tax ie profits from trade / profession

• But, only expenses of an income nature can be deducted

• e.g. money spent on stock, heating/lighting premises, insurance payments

Expenses

• Must be incurred ‘wholly and exclusively’ for the purposes of the trade or profession

• Some expenditure excluded by tax Acts, e.g. special rules for cars, pensions etc

Capital expenditure and allowances

• Capital expenditure is money spent on long term assets, premises, plant and machinery, etc

• Not of income nature and so not deductible from profits as an expense.

• Some capital items qualify for a capital allowance (also called depreciation)

Example of capital allowance

• Sole trader spends £10,000 on office furniture (capital asset)

• £ spent is not an expense (capital expenditure)• Can claim a capital allowance / depreciation

every year on the item• The main rate for capital allowances is 25%

every year on the net book value of the asset• Special rate for small & medium sized

businesses - 1st year only 50% (small) 40% (medium)

Example for a medium sized business

• 1st Year – asset purchased for £10,000– 10,000 x 40% = 4,000 (deductible)– At end yr 1 value is 10,000 - 4,000 =

6,000• 2nd year

– 6,000 x 25% = 1,500 (deductible)– At end yr 2 value is 6,000 – 1,500 = 4,500

• 3rd Year– 4,500 x 25% = 1,125 (deductible)– At end yr 3value is 4,500 – 1,125 = 3,375

Relevance to Income Tax

• The capital allowance figure (depreciation) not only used to reduce value of the asseton the balance sheet

• It also reduces the profit made in the same year for tax purposes

• Eg in yr 1 the business made £50,000 profit

• Capital allowance in year 1 was £4,000 so profit reduced to £46,000

Practice QuestionCapital Allowances

• Manisha is a sole trader and her business is classed as ‘small’.

• She buys a business asset in year 1 for £83,000.

1) Calculate the net book value at the end of year 1.

2) If her profit (after expenses) in year 1 is £125,000 calculate her taxable profit.

Answer

• Asset bought for £83,000• Cap All is 50% (in yr 1) = £41,500• End of yr 1 net book value = £41,500

• Profit in yr 1 = £125,000• Deduct Cap All of £41,500• Taxable profit = £83,500

Income Losses

• If the taxpayer makes a loss • (ie expenditure exceeds income)• it can be set off against profits made

– on income from other sources that year or

– on income from any source in the previous year (one year only) or

– on income from same trade only in future years (without time limit)

Losses made in early years and final year

• Losses made in first four years of a new business can be carried back against income from any source in the three years prior to the loss

• A loss made in the last year of the business can be carried back up to three years, but only against the profits of the same trade

Basis of assessment

• Assessed on the profits for the accounting period ending in the tax year

• Taxpayer chooses own accounting period (‘financial year’)

• Self assessment tax return sent to HMRC with the accounts and the tax due

• Special rules for opening and closing years of business (see p 24)

Example

• Sole trader’s financial year ends 30th September each year

• Tax for 2007 - 08 is based on accounts for period ending September 30th 2007

• Tax return to IR not later than 31st January 2009

• With cheque for tax due

Partnerships: income tax

• Partners are liable for their own tax on their share of the profits of the firm

• Each partner submits a tax return and the firm submits a partnership tax return, with a copy of the partnership accounts

• Each partner may have other income, different personal allowances, may choose different form of loss relief, etc.

• Partners not liable for each other’s tax liabilities

Partnerships: CGT

• Partnership sells a capital asset• Each partner liable to CGT on their

share of the gain.

VAT Chapter 11 p 52

Value Added Tax (VAT)

• Tax on supply of goods, services, sometimes land

• Supplier has to be registered for VAT (compulsory if turnover is £64,000)

• Supplier charges customers VAT• sends VAT collected (output tax) less

VAT paid to others (input tax) with quarterly VAT return

VAT Rates

• Standard rate 17.5%• Zero rate 0%• Special rate 5%• Some supplies exempt

Example

• Builder supplies £100,000 worth of services

• If all charged at 17.5%• Output tax = 100,000 x 17.5% = £17,500• Builder buys £60,000 worth of goods• If all charged at 17.5%• Input tax = 60,000 x 17.5% = £10,500• Builder pays 17,500 - 10,500 = £7,000

VAT

Registration

• Compulsory if turnover is £64,000• Voluntary registration may be

beneficial if:– most supplies are zero rated or exempt, or– useful to register when set up business

then de-register

• Allows VAT paid out to be reclaimed (otherwise not possible)

Solicitors’ Disbursements

• A disbursement is money paid out on behalf of a customer on their instructions

• Examples are stamp duty and search costs incurred when conveyancing

• These may be excluded from the VAT account so that VAT does not have to be charged to the client

Stamp duty

Chapter 12 p 54

Stamp Duty

• Historically a tax on documents• Document had to be stamped to

show the tax has been paid• Paid by purchaser• System recently changed with

intro of Stamp Duty Land Tax (SDLT)

Shares and other securities

Calculated as a percentage of the value

Transfers of shares, etc. 0.5%– Round up the tax to the nearest £5.00– Not payable on gifts

Time limit

• Document must be stamped within 30 days after execution

• Financial penalties for late stamping

SDLT

• Duty payable on all UK property transactions – freehold and leasehold

• See handbook for basic details

Next lecture

• Corporation tax

• See chp 10 tax handbook