Income and expenses – helpful hints for the tax return

Read our 14 examples of common adjustments

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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.

1. 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.

2. 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 whilst 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.

3. 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 their spouse or civil partner or by any child of theirs 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.

4. 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.

5. 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.

6. Expenditure on qualifying courses for retraining past or present employees for future employment elsewhere

Under S34(1) ITTOIA 2005 expenditure is disallowed if it is not incurred wholly and exclusively for the purposes of the business in question. However, the existence of some non-business benefit arising out of expenditure does not cause it to be disallowed if, in fact, the expenditure is incurred exclusively for business purposes. So, expenditure on the training and development of staff whose relationship with their employer is limited to the employment itself is allowable. This remains the case where the expenditure is on the development of an employee's skills and attributes which may not be directly related to their current job with the employer. Where, on the other hand, an employee on whom the expenditure is incurred has a significant proprietary stake in the business, or is a relative of those who do, there is obviously a much greater chance that expenditure may have been incurred not, or not wholly, for business purposes, but to provide the employee with some personal benefit. If that is the case, then the expenditure is not deductible - the business purpose has to be the exclusive purpose. To take an extreme example, there could be no allowance for the educational costs of the business proprietor's child who is employed in the business during university holidays. In such cases, you need to assess whether the expenditure would have been incurred on an otherwise unconnected employee doing the same job.

Where an employee incurs expenditure on a training course, a deduction is not generally available under ITEPA 2003, s.336 as the expense will not usually be incurred ‘wholly, exclusively and necessarily’ in the performance of the employee’s duties of employment. The expenditure will be regarded as personal rather than being required by the job, even if the employer requires the employee to attend such a course; or the training is essential to the promotion prospects of the employee.

7. Training costs of the taxpayer (proprietor's training courses)

Costs incurred in maintaining, updating and developing existing skills while qualified are allowable, because there is a direct link between the expense incurred and income received. The cost incurred in the acquisition of new expertise is not allowed.

8. Fees and subscriptions

An annual subscription to a body shown in the list, as approved by HMRC, is allowable.

9. Accountancy fees

HMRC will not allow a deduction for the cost of preparing an individual’s personal tax return. However, accountancy fees for the preparation of business accounts are allowable expenses.

10. Website cost

A website that will directly generate sales, subscriptions, advertising or other income will normally be regarded as creating an enduring asset and consideration should be given to treating the costs of developing, designing and publishing the website as capital expenditure. Whilst a revenue deduction would not therefore be allowable, this capital expenditure will generally qualify as expenditure on plant and machinery for capital allowances purposes. Expenditure on initial research and planning, prior to deciding to proceed with the development of a website, is normally allowable as revenue expenditure.

The regular update costs of the website are likely to be revenue expenses and so allowable for tax purposes.

11. Relocation expenses

If the business is not moving to a larger premises such expenses are allowed. However, if the business is moving to a significantly larger location, such that removal costs will be an ‘enduring benefit’ to the trade, the expenses are capital in nature and not allowed.

12. Fines and penalties

Penalties/fines for a breach of regulations, or as the result of a prosecution for a trader’s breach of regulations, will not be an allowable expense. However, payments for damages that are compensatory rather than punitive are tax deductible. That includes, for example, damages for defamation payable by a newspaper company, where such claims are ‘a regular and almost unavoidable incident of publishing’.

Also, where an employer pays fines that are the liability of an employee, so that the employee is taxable on the payment as employment income, the cost to the employer of paying the fines is allowable in computing their trading profits.

13. 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 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.

14.  High Income Child Benefit Charge

If a taxpayer has an individual income over £50,000 and either they or their partner get Child Benefit, some of the child credit received would be clawed back via the self-assessment.