The taxation of the unincorporated businesses will be the main point of focus in this blog. The working of profit of business will be done as a separate entity as it is described in the rules of business setup UK but the taxation of unincorporated business having formation of Great Britain can’t be done separately. The calculation and taxation of profits will be discussed by making the point clear that the standard rules for the calculation of profits will be used and not the policies in case of individual traders. The examples of particular law cases will be given for the convenience of readers.
All about the Badges of Trade
In order to make the decision of the existence of a trade, the badges of trade can be brought under utilization. The establishment of the existence of trade is mandatory before the imposition of a charge of tax.
The definition of a trade in the legislation can only be given in an unhelpful way as including any venture in the trade’s nature. Hence, the matter is left in the hands of courts for the provision of guidance. This guidance is basically a summary of a collection of principles, which are referred to as the badges of trade. The taxation of the profits from vocations and professions is done in the same manner as the profits from trade.
Examination of the Subject Matter
The decision that whether a person is in trade or not may sometimes be made through the examination of the subject matter of the transaction. The holding of some assets is commonly done in the form of investments as their intrinsic value: an individual making the purchase of some shares or a painting may do so, so that he can enjoy the income acquired from shares or to amuse himself from the work of art. The production of a gain of capital nature may be done by a subsequent disposal instead of a trade profit. However, in some cases it is presumed that any profit on a resale is a profit from trade, for example, the case where the subject matter of a transaction would not be held in the form of investment (such as 34,000,000 yards of aircraft linen (Martin case 1927) or 1,000,000 rolls of toilet paper (Rutledge case 1929).
The interpretation of the transactions that are of capital nature in isolation is done in the form of trading transactions where the carrying on of a trade is indicated by their frequency. In the case of Pickford 1927, a decision was made that while in a normal manner, the purchase of company owning a mill and the subsequent stripping of its assets might be labelled as a capital transaction, where the taxpayer was embarking on the same exercise for the fourth time they should be carrying on a trade.
If there is existence of a trade, then a similarity to the transaction under consideration may point to that transaction having a trading nature. Consider the example of a builder who is involved in building and selling a number of houses who may be held to be trading despite the fact that they retain one or more houses for longer duration than usual and makes a claim that their holding was done in the form of investment (Harley Case 1952).
The adventures in the nature of trade may be inferred by the courts where the items bought can be sold soon afterwards.
In the case of the transactions being operated in a similar manner as some person who is undeniably trading, it may be inferred by the court that a trade is being carried on. Consider the example of a person who made the purchase of a consignment of whiskey and then made its sale through an agent, in a similar manner as others who were operating the trade, was also held to be carrying on a trade (CIR Case 1942). On the contrary, if the sale of an asset has to be made for the purpose of raising funds in emergency, it is less probable that it will be considered as trading.
The courts will be more willing to ascribe a motive of trading when the performance of work is noted to render an asset more marketable or steps are taken in order to find the purchasers. When a quantity of brandy was bought, blended and recasked by a group of accountants, they were held to be liable to tax on a trade profit when later, the sale of brandy was made (Cape case 1921).
Motive of Profit
It should be noted that the tax charge will not be precluded necessarily as income from trade due to the absence of a profit motive, but if its presence is noted, it strongly indicates that a person is trading. According to the Wisdom case 1969, the buying and resale of £20,000 worth of silver bullion by the comedian Norman Wisdom, as a hedge against devaluation was held to be a transaction of trade.
Way of Acquisition of the Asset whose Sale is Made
An indication of trading is given in the case of deliberate acquisition of the goods. If the acquisition of the goods takes place unintentionally, such as through gift or inheritance, their later sale is not likely to be a trading.
In order to purchase an asset, if the buyer has to borrow some money such that they have to make a sale of that asset instantly for the repayment of loan, it may be inferred that there was a trading going on. This was a factor in the Wisdom Case, where Mr. Wisdom financed his purchases by loans at a high interest rate. It became clear that he had to make a sale of the silver bullion quickly for the repayment of loan and prevent the charges of interest becoming too onerous. On the contrary, taking out a long term loan in order to purchase an asset (for example, a mortgage on a house) would usually not indicate the operation of a trade.
Intentions of the Taxpayer
The intentions of the taxpayer do not remain relevant when it becomes clear that the trading of a transaction is being done on objective criteria. However, in case if there is a dual purpose of the transaction, then the accountability of the intentions of the taxpayer may be done. An example of a transaction with a dual purpose is to acquire a site partly as premises from which to carry on another trade, and partly with the objective of possible development and resale of the site. This test is not one of the traditional trade badges, but its importance may be equivalent.
In case if it is not concluded by the HMRC that an income is a trade income after the application of badges, then their treatment can be done potentially in the form of other income or a capital gain. It should be remembered that the taxation of capital gains is done at a maximum rate of 28% while the taxation of income is done at a maximum rate of 45%. Hence, the HMRC will be looking carefully to determine if a transaction actually results in a capital gain or if it is actually a receipt of trade.
Trade Profits Computation
After the business formation of Great Britain the adjustment of the accounts profits is required to be done for the establishment of taxable trade profits.
During the computation of the taxable trade profits, the shown net profit in the statement of loss or profit is the starting point. For the calculation of taxable amount, it is possible that many adjustments may be needed.
The deductible and non-deductible expense may be referred to as allowable and disallowable expense respectively. The two terms’ sets can be used interchangeably.
The main concept states that the calculation of the profits of business having business formation UK should be done according to the generally accepted accounting practice. These profits can be adjusted as particularly required for the purposes of income tax.
The treatment of the capital allowances under the capital allowances act 2001 is done in the form of expenses of trade and the treatment of balancing charges is done in the form of trade receipts.
Under the business formation UK there are some certain expenses that are particularly prohibited by the legislation, as described in the text below. However, if a subtraction is allowed particularly, this results in overriding the disallowance.
The capital expense is not to be subtracted as income tax is a tax liable merely on income. This results in the denial of a deduction for amortization or depreciation although special rules exist for the companies having relation with intangible assets. Repairs or the revenue expense and improvements (capital expense) will often be the most contentious items of expenditure.
For example, the restoration cost of an asset replacing a subsidiary part of the asset is revenue expense. Expense on the chimney replacement of the new factory was allowable as the chimney was a subsidiary part of the factory (Samuel case 1951). However, according to another case, the demolishment of a stand of spectator by a football club and replacement of it by modern equipment took place. This was not held to be a repair, as repair is considered to be the restoration by renewing or replacing the subsidiary parts of a larger entity, and the stand formed a separate and distinct part of the club (Brown case 1980).
The cost of initial repairs for the improvement of asset recently needed to make it fit in order to earn profits is considered to be a disallowable capital expense. According to the Law case 1923, the taxpayer was not successful to acquire relief for expense on making the ship worthy of the sea that was bought recently, before bringing it underutilization.
The cost of initial repairs is allowable if they are to remedy the normal wear and tear of the assets whose acquisition is done in the recent past. The Odeon case 1971 can be contrasted with the law case. Odeon got a permission to charge expense suffered for the improvement of state of the cinemas that have been acquired in the recent past.
There are other examples to be considered including:
A one-off payment for the removal of a threat to the business of taxpayer having business name registration UK was also held to be revenue instead of the capital expense in the case of Lawson 1992.
The one-off payment made by the owner of a hotel in order to terminate an agreement for the hotel management was held to be revenue instead of capital expense in the case of Croydon 1996. The whole structure of the business of the taxpayer was not affected by the payment, it only enabled its function to be carried out in a more efficient way. The initial payment in the case of a franchise (as opposed to fee at regular basis) is considered to be capital expense and not the one to be subtracted.