INCOME FROM SELF EMPLOYMENT

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INCOME FROM SELF EMPLOYMENT
Theory and practice of taxation AModule C33TA1
Lecture 16
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THE PROS AND CONS OF SELF-EMPLOYMENT

• Income Tax and Class 4 NI on trading profits is
  paid in 2/3 instalments - Income Tax and NI on
  salaries is paid monthly/weekly
• Employees may pay higher NI contributions than
  the self employed (but also receive higher
  benefits!)
• Employees may receive benefits as well as
  salaries. Their taxable value may be less than
  their actual value
• Rules on deductibility of expenses for employees
  is much stricter than the self employed

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INCOME FROM SELF EMPLOYMENT These criteria to
distinguish

• Contract of service (employee Employment
  Income)
• Contract for services (self employed Trading
  Income)
• have been built up by case law
• Control
• Financial risk
• Equipment
• Work performance and correction
• Holiday and sickness
• Exclusivity

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INCOME FROM SELF EMPLOYMENTTrading Income

• Assessment of income
• Profits of a trade
• Profits of a profession or vocation

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TRADING DEFINED Does the selling of goods and
services constitute a "trade" (trading activity)?

• ICTA 1988 definition
• Trade includes "every trade, manufacture,
  adventure or concern in the nature of trade"
• 1954 Royal Commission
• defined the main criteria to identify a trading
  activity called
• The Badges of Trade

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THE BADGES OF TRADE

• Subject matter of the transaction (Rutledge v
  CIR Martin v Lowry)
• Length of period of ownership (Wisdom v
  Chamberlain)
• Frequency of transaction (Pickford v Quirke)
• Supplementary work (Cape Brandy Syndicate v CIR)
• Reason for the sale (Taylor v Good)
• Motive (Wisdom v Chamberlain)

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CALCULATION OF THE TAXABLE PROFIT

• Trading Profit
• Generally accepted accounting principles (eg
  FRSs) are mostly followed in calculating taxable
  profits
• The net profit in the businesss profit and loss
  account will be used as a starting point
• Then a number of adjustments are needed

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Profit adjustment

Net profit shown by the
accounts X ADDExpenditure included in the
accounts net profit
but not deductible for tax purposes X
Trading Income assessable but
not included in the accounts.
X X LESS Income included in the
accounts but not assessable
X Expenditure
deductible for tax purposes but not included in
the accounts. X X Profit adjusted
for tax purposes X
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Profit adjustment

• Profit and loss account
  
• Sales
  10,000
• Less expenses
• General (allowable) 3,500
• Entertainment (not allowable) 600
  
  4,100
• Net profit
  5,900
• What is the taxable profit?

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Profit adjustment

• Taxable 10,000 - 3,500 6,500
• Calculation
• 
  
• Net profit per accounts 5,900
• Add Expenses not allowed 600
• Trading profit for tax 6,500

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EXPENDITURE DEDUCTIBLE

• Must be "wholly and exclusively for the purpose
  of the trade"
• Must be connected with the trade and thus have
  the purpose of earning profits. The remoteness
  test
• Strong Co of Romsey Ltd v Woodfield 1906
  (compensation paid to customer injured by falling
  chimney - not deductible)
• Bamford v ATA Advertising Ltd (misappropriation
  by a director - disallowed)

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EXPENDITURE DEDUCTIBLE

• Must be "wholly and exclusively for the purpose
  of the trade
• Must not reflect more than one purpose. The
  duality test
• In principle if the expenditure has both a
  business and private purpose it should all be
  disallowed.
• Caillebotte v Quinn (self-employed carpenters
  excess lunch costs - not allowed)
• Mallalieu v Drummond (lady barristers black
  court clothing - not allowed)

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EXPENDITURE DEDUCTIBLE

• Must be "wholly and exclusively for the purpose
  of the trade
• BUT in practice
• only the private element will be disallowed
  provided the expenditure can be apportioned
  between business and private usage with
  reasonable accuracy.
• And cost of overnight expenses plus reasonable
  charges for dinner and breakfast, incurred on
  business - allowed.

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MAIN CATEGORIES OF DISALLOWABLE EXPENDITURE 1

• CAPITAL EXPENDITURE
• "Capital" is not defined must look to case law
• Expenditure that brings an "enduring benefit" to
  the business.
• Law Shipping Co Ltd v CIR 1926
• Odeon Theatres v Jones 1971
• Cost of restoration of an asset by replacing a
  subsidiary part e.g. a new factory chimney is
  allowable (Samuel Jones Co.Ltd. v CIR)
• Replacement of the entire asset is capital (Brown
  v Burnley Football Club)
• All items associated with the capital
  expenditure e.g. legal and professional fees,
  delivery/installation costs

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MAIN CATEGORIES OF DISALLOWABLE EXPENDITURE 2

• OTHER ITEMS
• One-off payment by a hotel owner to terminate a
  management agreement for the hotel - revenue
  (Croyden Hotel and Leisure Co v Bowen)
• One-off payment to remove a threat to the
  taxpayers business - also revenue
  (Lawson v Johnson
  Matthey plc)
• BUT
• An initial payment for a franchise is capital

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MAIN CATEGORIES OF DISALLOWABLE EXPENDITURE 3

• Appropriations of profit (interest on
  proprietors capital, proprietors salary etc)
• Depreciation, amortisation (eg of a lease see
  later slide)
• Private element of motor expenses, rent,
  heat/light, telephone, etc
• Charges on income
• These are deductible from Statutory total
  income (based on amount paid)
• Therefore not deductible from Trading Income
  income as well
• If included in profit and loss account (probably
  on accruals basis) they will need to be added
  back to arrive at Trading Income

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MAIN CATEGORIES OF DISALLOWABLE EXPENDITURE 4

• Expenditure on entertainment
• Unless it is reasonable staff entertainment.
  Reasonable 150 per head
• If made to employee they may be assessed under
  Employment Income and then it would be deductible
  from Trading Income
• Expenditure on gifts unless
• gift is for less than 50 per head, displays a
  prominent advert, and is not food, drink or
  tobacco OR
• Gift is to an educational establishment or to a
  charity and meets the "wholly and exclusively"
  test.
• (NB charitable donations may be made Gift Aid and
  tax relief be obtained under the gift aid scheme
  and therefor not deductible under Trading Income
  )

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MAIN CATEGORIES OF DISALLOWABLE EXPENDITURE 5

• Non-trade bad debts
• General Provisions (eg doubtful debts) (movements
  in)
• Criminal payments
• Fines and Penalties
• Political donations

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ALLOWABLE EXPENDITURE

• Most expenditure included in P L account. Note
  also
• Professional fees relating to revenue expenditure
• collection of trade debts
• raising of long term finance
• renewal of a short term lease (less than 50
  years)
• action for breach of contract
• preservation of title
• Audit and accountancy fees (including normal
  agreement of tax liability) BUT fees associated
  with appeals and investigations are not allowable
  - (private expenditure of the taxpayer).
• Subscriptions to professional and trade
  associations allowable.

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ALLOWABLE EXPENDITURE

• Payment of damages allowable
• Losses through staff dishonesty allowable
• BUT not if by owner or senior member of
  management.
• Large salaries to members of the owners family
  could be disallowed if deemed not to be paid for
  trading purposes.
• Redundancy payments and compensation for loss of
  office generally allowable.
• Proprietors travelling expenses between places
  of work allowed (which will include between home
  and other place of work if business is conducted
  from home) but travel between home and work is
  disallowable.

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ALLOWABLE EXPENDITURE

• Hire and leasing costs of plant and machinery is
  allowable but a proportion of the cost of car
  hire will be disallowed if cars original cost
  exceeds 12,000.
• Allowable amount
• hire charge x 12,000 1/2(cost of
  car-12,000) /cost of car
• Charitable donations are only deductible if small
  and made to local charities (but NB Gift Aid
  provisions)
• Interest paid for business purposes is allowable
• Pre-trading expenditure (of a business nature)
  made within 7 years of starting is deemed to have
  been undertaken on the first day of trading and
  is thus allowable.
• Removal expenses to new business premises as part
  of an expansion are allowable

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Profit adjustment

Net profit shown by the
accounts X ADDExpenditure included in the
accounts net profit
but not deductible for tax purposes X
Trading Income assessable but
not included in the accounts.
X X LESS Income included in the
accounts but not assessable
X Expenditure
deductible for tax purposes but not included in
the accounts. X X Profit adjusted
for tax purposes X
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Income assessed as Trading Income but not
included in the accounts

• Own consumption of goods and services
• Proprietor taking goods from stock or getting the
  business to provide a service for his personal
  consumption.
• Profit to the business must be calculated based
  on the assumption that it has been supplied at
  normal selling price.
• If the goods has been recorded at below this
  price adjustment must be made to the accounts.
  (Sharkey v Werner 1955)

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Profit adjustment

Net profit shown by the
accounts X ADDExpenditure included in the
accounts net profit
but not deductible for tax purposes X
Trading Income assessable but
not included in the accounts.
X X LESS Income included in the
accounts but not assessable
X Expenditure
deductible for tax purposes but not included in
the accounts. X X Profit adjusted
for tax purposes X
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Income included in the accounts but not
assessable

• Income taxed under other heads
• Profits or losses on disposal of fixed assets
• Transfers from (decreases in) general provisions
  that have previously not been allowed.

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Profit adjustment

Net profit shown by the
accounts X ADDExpenditure included in the
accounts net profit
but not deductible for tax purposes X
Trading Income assessable but
not included in the accounts.
X X LESS Income included in the
accounts but not assessable
X Expenditure
deductible for tax purposes but not included in
the accounts. X X Profit adjusted
for tax purposes X
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Expenditure deductible but not included in the
accounts.

• Capital allowances
• Depreciation will have been disallowed
• Premium paid for a short lease for business
  premises
• Amortisation charge will have been added back

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Amortisation of lease

• The premium was 30,000
• Bees expense
• Premium assessable on Al 24,600
• Annual expense 24,600/10 (yrs of lease)
• 2,460 for 10
  years
• Year end 31 Dec 2006 1/2 X 2460 1230
• then 9 yrs _at_ 2460
• then last year _at_1230
• Amortisation in accounts will probably be
  30,000/10 3,000 p.a.

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