COURSE: ACCA – TAXATION (TX)

Lecture Topic: Trading Income

1. The adjustments to accounting profit

An individual’s income from a trade or profession is referred to as trading profit (or trading income).

When computing trading income, the fundamental concept is that the profits of the business must be calculated
in accordance with generally accepted accounting practice. However, these profits are subject to certain
adjustments specifically required for income tax purposes.

The net profit before taxation (accounting profit) shown in the income statement is used as the starting point in
computing the trading profit for tax purposes.

The following adjustments are made to the accounting profit in order to arrive at the trading profit figure
for inclusion in the income tax computation:

£ £

Net profit per accounts 140,000

Add: (i) Expenditure charged in the accounts

which is not allowable (not deductible) for tax purposes 50,000

(ii) Income taxable as trading income

which has not been included in the accounts 30,000
80,000
220,000
Less: (i) Income included in the accounts
which is not taxable trading income 40,000

(ii) Expenditure that is deductible (allowable) for tax purposes,

but which has not been charged in the accounts 20,000

(iii) Capital allowances 10,000

(70,000)
Trading Profits adjusted for tax purposes 150,000

Notes:

1. All items listed in the question should be dealt with, indicating with a zero (0) any items which do not
require adjustment.

2. Trading income is computed for the business’ period of account. The period of account is the period for
which the business prepares accounts.

1
1.1 Deductible and non-deductible expenditure

Certain expenses are specifically disallowed by legislation, i.e. they are not deductible (not allowable) in
computing trading profit.

(a) Capital expenditure is not allowable for tax purposes.

(b) Repairs are allowable, but the distinction between repairs and capital expenditure is not always clear
cut. The following rules should make it easier to distinguish between the two:

Type of ‘Repair’ Allow Disallow

(i) Repairs/ Redecorations Normal Repairs Improvements

(ii) Initial repairs (this is
where a used asset is
bought and repaired before If the asset is usable before If the repairs are necessary
being used in the business) the repairs are carried out to make the asset usable

If the restoration renews a Renewal of a separate

(ii) Restoration costs subsidiary part of an asset asset

(c) Depreciation and amortisation are not allowable for tax purposes.

(d) Loss on sale of fixed assets is not allowable.

(e) Trade or professional association subscriptions relating to the trade are allowable.

(f) Charitable donations are allowable if they are small and to local charities. If tax relief is available for
the donation under the gift aid scheme, then it is not an allowable trading expense.

(g) Entertainment expenditure is not allowed, except in relation to employees (allowable).

(h) Gifts to employees are normally allowable.

Gifts to customers are allowable if:

- they cost less than £50 per recipient per year, and
- the gift is not food, drink, tobacco or vouchers exchangeable for goods, and
- the gift carries a conspicuous advertisement for the company

(i) Impaired trade receivables (bad debts)

The write off of an impairment loss (bad debt) that relates to the trade (a trade debt) is allowable.
The write off of a non trade debt, e.g. a loan to an employee etc. is not allowable.
A provision for specific impairment debts is allowable; a provision for general debts is not allowable.

2
(j) Legal and professional fees relating to capital or non-trading items are not deductible. Example:

Disallow:
- fees incurred when acquiring new capital assets or legal rights
- fees arising as a result of issuing shares
- fees incurred when drawing up partnership agreements and litigating disputes over the terms of
a partnership agreement.

Allow:
- legal fees to collect trade debts
- charges incurred in defending the title to fixed assets
- charges connected with an action for breach of contract
- expenses of the renewal (not the original grant) of a lease for less than 50 years
- normal charges for preparing accounts/ assisting with the self assessment of tax liabilities
- incidental costs of obtaining loan finance

(k) Appropriations of profit (i.e. drawings, salary or interest on capital paid to a proprietor) are not
allowable expenditure.

(l) Interest paid for business purposes on a loan or overdraft is allowable on an accruals basis. However,
deductible interest is not allowable.

(m) Patent royalties and copyright royalties paid in connection with an individual’s trade are allowable as
trading expenses.

(n) If a car is leased for use in the business, the leasing costs will normally be an allowable expense.

If the car’s CO2 emissions exceed 50g/km, then 15% of the leasing costs will be disallowed.

(o) Expenditure that is not incurred wholly and exclusively for trading purposes is disallowed.

(p) If a sole trader includes any personal/private expenses in the income statement, these are not allowable
for tax purposes. If an expense has both business and private elements, then the percentage or proportion
of the expense that relates to the private element must be disallowed.

(q) Any salary paid to a member of the trader’s family must not be excessive, i.e. it must be at the
commercial rate for the work done. Any excessive salary payments must be disallowed.

(r) Pre-trading expenditure incurred in the seven years before the trade begins is allowable if it would have
been allowable had the trade already started. It is treated as a trading expense incurred on the first day of
trading.

(s) If earnings for employees are charged in the accounts but are not paid within nine months of the end of
the period of account, the cost is only deductible for the period in which the earnings are paid.

3
 (t) Other minor items that may be included in questions are:

Item of Expenditure Treatment Notes

Compensation for loss of office (Redundancy payments) Allow Only if for benefit of trade
Only for trades (not professions or
Cost of registering patents and trademarks Allow vocations)
Counseling and retraining services provided for redundant
employees Allow
Only if paid in connection with a
Damages paid Allow trade matter

Educational courses for staff Allow

If to update existing knowledge or
Educational courses for trader Allow skills
Exception – see Parking Fines
Fines and Penalties Disallow below
Only NICs paid by the employer -
National Insurance Contributions (NICs) Allow Class 1 Secondary and class 1A
Unless incurred on business by
Parking Fines Disallow employee (not proprietor)

Payment that constitutes a criminal offence Disallow

Penalties and interest on late tax paid Disallow

Provision of a car, ship or dwelling
Personal security expenses Allow is excluded

Pension contributions made by the employer Allow Provided paid by year end
Premiums for insurance against an employee’s death or
illness Allow Receipts are taxable

Removal expenses (to new business premises) Allow Provided not an expansionary move

Travelling expenses to the trader’s place of business Disallow Unless an itinerant trader

4
1.2 Income taxable as trading income that was not included in the accounts

When a trader removes goods from the business for his own use, he is treated as making a sale to himself based
on the selling price of the goods concerned. Therefore, in computing trading profits, the trader must include the
selling price of the goods as income (if this was not done so before).

1.3 Income included in the accounts that is not taxable as trading income

These fall into three categories as follows:

(i) Capital Receipts (e.g. profit on the sale of an asset)

(ii) Income taxed in another way (e.g. interest income, property business income etc.)
(iii) Income that is exempt from tax (e.g. interest on an ISA)

The fact that an item of income (such as interest received) is to be excluded does not mean that it is not taxable;
only that it is not taxable as trading income. Any amounts that are subject to income tax must be included
elsewhere in an individual’s personal income tax computation.

1.4 Allowable expenditure not charged in the accounts

The two main items that fall into this category:

(i) Capital allowances, which are usually shown separately (refer to adjustment format),

(ii) When a trader has paid a lease premium to a landlord who is taxable on the premium as property
business income, the amount deductible (for the trader) per annum is calculated as follows:

The property business income of the landlord

The duration of the lease

The property business income of the landlord is calculated as:

P × 51 - D
50

Where: P = total premium

D = duration of the lease in years

Normally, the amortisation of the lease will have been deducted in the accounts and must be added
back.

5
Question 1

Charles runs a small printing business. His accounting results for the year ended 31 March 2023 are:

Note £ £
Gross profit from trading 156,000
Bank interest received 3,000
159,000
Less: Expenses
Staff wages 42,000
Advertising 1,350
Depreciation 16,000
Bad debts 1 3,500
Motor car expenses 2 2,400
Repairs 3 3,750
Miscellaneous expenses 4 10,000
(79,000)
Net Profit 80,000

Notes

1. The charge for bad debts included the following items: £

Write off of trade debts 2,500

Increase in general provision for debtors 1,000

2. Charles uses the motor car 75% for business purposes and 25% for private purposes.

3. Repairs comprise the following expenditure: £

Refurbishing a second hand press before it could be used 3,500

Decorating offices 250
3,750

4. Included in miscellaneous expenses were gifts to customers of:

£
- Calendars costing £7.50 each and bearing the business’ name 750
- Food hampers costing £30 each and bearing the business’ name 300

5. During the year ended 31 March 2023 Charles took goods out of the shop for his children’s use without
paying for them, and no entry has been made in the accounts to record this. The goods cost £600 and
had a selling price of £900.

6. The capital allowances available for the year ended 31 March 2023 are £11,000.

Calculate Charles’ trading profit for the year ended 31 March 2023.

6
Question 2

On 1 June 2021 William Wise commenced in self-employment running a retail clothing shop. William’s income
statement for the year ended 31 May 2022 is as follows:

£ £
Gross profit 139,880
Expenses:
Depreciation 4,760
Light and heat (note 1) 1,525
Motor expenses (note 2) 4,720
Professional fees (note 3) 2,300
Rent & rates (note 1) 3,900
Repairs and renewals (note 4) 5,660
Sundry expenses (note 5) 2,990
Wages and salaries (note 6) 83,825
(109,680)
Net profit 30,200

Note 1 – Private accommodation

William and his wife live in a flat that is situated above the clothing shop. Of the expenditure included in the
profit and loss account for light, heat, rent and rates, 40% relates to the flat.

Note 2 – Motor expenses

During the year ended 31 May 2022 William drove a total of 12,000 miles, of which 9,000 were for private
journeys.

Note 3 – Legal & Professional fees

Legal & Professional fees were paid for the following items:
£
Accountancy 450
Trade debt collection 400
Legal fees in connection with the purchase of the clothing shop 1,450
2,300

Note 4 – Repairs and renewals

The figure of £5,660 for repairs and renewals includes £400 for decorating the clothing shop during April 2021,
and £1,050 for decorating the private flat during June 2022.

7
Note 5 – Sundry expenses

The figure of £2,990 for sundry expenses includes £640 for gifts to customers of food hampers costing £40
each, £320 for gifts to customers of pens carrying an advertisement for the clothing shop costing £16 each, £100
for a donation to a national charity, and £40 for a donation to a local charity.

Note 6 – Wages and salaries

The figure of £83,825 for wages and salaries includes the annual salary of £15,500 paid to William’s wife. She
works in the clothing shop as a sales assistant. The other sales assistants doing the same job are paid an annual
salary of £11,000.

Note 7 – Goods for own use

During the year ended 31 May 2022 William took clothes out of the shop for his personal use without paying for
them. The cost of these clothes was £460, and they had a selling price of £650.

Note 8 – Plant and Machinery

The capital allowances available for the year ended 31 May 2022 are £13,060. In the exam you were required to
do a capital allowances computation and work out this figure.

Required:

Calculate William’s trading profits for the year ended 31 May 2022.