Taxable and non-taxable receipts
Income tax is charged on the profit of a trade, profession or vocation. In order to be taxable the receipt must represent ‘the profits of’ the trade under S5 ITTOIA 2005. An incoming payment is not necessarily a trade receipt solely because nothing would have been received had the trade not been carried on.
This was highlighted in the case Murray v Goodhews. The receipt of compensation (ex-gratia payment) by a pub landlord as a result of the cancellation of his pub tenancy was held as not being taxable.
Also, if receipts are unsolicited and totally unexpected, they will not be taxable. In Simpson v John Reynolds & Co, an insurance broker who received a ‘consolation’ when a long-standing client ceased the business relationship after being taken over by a company which used a different supplier, was held not to be taxable. The courts held that a voluntary payment after the end of a business relationship, with no prospect of further services, was not taxable income.
However, if the amounts are expected, they will be taxable.
In Rolfe v Nagel a voluntary payment by one diamond broker to another under an arrangement that had no legal force was held to be a trading (taxable) receipt. The courts indicated that a decision in such case should have regard to the character of the receipt in the hands of the recipient, rather than to the motives of the payer.
Similarly, in McGowan v Brown & Cousins compensation received by an estate agent following the cessation of the business connection was taxed as trading income as it related to trade, and was solicited and expected by the estate agent.
Common adjustments in tax returns
Adjustments may arise in connection with the tax treatment of the following expenses.
- Pre-trading expenses: Expenditure of a revenue nature incurred in the seven years preceding the commencement of a trade, profession or vocation is deducted from profits in the first accounting period, provided that the expenditure would have been allowable if incurred after the trade had commenced.
- Expenditure on food or drink for consumption by the trader: The cost of food and drink consumed, and accommodation used, by a trader is not, in general, an expense incurred wholly and exclusively for the purposes of the trade since everyone must eat in order to live, and such costs are therefore usually disallowed. However, expenses incurred by a trader on food and drink while travelling on business will be allowable where the business travel is, itself, allowable and the trade is, by its nature, itinerant or involves travel to a place only occasionally visited and not as part of the trader’s normal pattern of travel for the trade. Where a business trip by a trader necessitates one or more nights away from home, the hotel accommodation and reasonable costs of overnight subsistence are deductible.
- Travel expenses connected with foreign trades: If an individual carries on a trade wholly outside the UK (a foreign trade), a deduction is allowable in calculating the profits of the trade for certain expenditure on travel, board and lodging incurred in connection with that trade, and which would not otherwise be allowable solely due to its failing to meet the ‘wholly and exclusively’ test. If the trader’s continuous absence from the UK lasts 60 days or more, the expense of a journey made by his/her spouse or civil partner or by any child of his/hers between a UK location and the location of any of the trades in question, where that journey is made in order to accompany the trader, is also allowed. The deduction is limited to the expenses of two such outward journeys and two return journeys per person per tax year.
- Incidental cost of loan finance: A statutory deduction in computing the profits of a trade applies to the incidental costs of raising loan finance which would otherwise not be an allowable deduction. There are special rules regarding the incidental costs of raising loan finance for businesses using the cash basis. Interest payments on a loan taken out for a business purposes are allowable for tax purposes. This includes overdraft interest, providing the related bank account is a genuine business account and is not used to fund personal expenses. No deduction is allowed for the repayment of the capital part of the loan. No deduction is allowed for interest on overdue tax.
- Premiums payable by a trader for business premises where the premium is treated as a property business receipt by the landlord: Where land used in connection with a trade is subject to a taxed lease, the tenant under the lease is treated as incurring a revenue expense. ITTOIA05/S277(4) expresses the amount of the premium to be treated as rent in the formula: P x (50-Y)/50 where P = the premium and Y = the number of complete years in the term of the lease apart from the first. The amount of the expense for each day is equal to the amount of the taxed receipt divided by the number of days in the receipt period.
- Fees and subscriptions: What is allowable? A fee or sub is allowable if it is in the list below and is a statutory fee or contribution where employees pay this out of their earnings from an employment and are required to pay this as a statutory condition of their employment, or is an annual subscription to a body where employees pay this out of their earnings from an employment and the activities of the body are directly relevant to the employment, or where the activities of a body are directly relevant to an employment where the performance of the duties of that employment is either:
– directly affected by the knowledge concerned
– involves the exercise of the profession concerned
You can view the list of deductions for fees and subscriptions paid to professional bodies or learned societies.
- Gift aid: Gift Aid payments are made net of 20% basic rate tax, if the taxpayer is a basic rate taxpayer no further adjustment needs to be made. If the taxpayer is a higher rate taxpayer, then an additional relief is given by extending the basic rate band by the gross amount of the contribution made. A person can use a Gift Aid claim only if the amount of Income Tax and/or Capital Gains Tax he paid for the tax year in which he makes the donation is at least equal to the amount of basic rate tax the charity will reclaim on that gift. If the person does not pay enough tax he will need to pay any shortfall in tax to HMRC via the self-assessment.
- High Income Child Benefit Charge: If a taxpayer has an individual income over £50,000 and either he or his partner get Child Benefit some of the child credit received would be clawed back via the self-assessment.
- Student loan repayment: The earliest a repayment of a student loan will start is 6 April after the person leaves the course. The income needs to be £16,910 a year before repayments start. The amount paid back is calculated as 9% of the income over the starting limit. See HMRC’s leaflet