Taxation of the unincorporated business for P6 (UK)

The new business (for P6 (UK))
Part 4 of 4

This is the Finance Act 2015 version of this article. It is relevant for candidates sitting the P6 (UK) exam in the period 1 September 2016 to 31 March 2017.
Candidates sitting P6 (UK) after 31 March 2017 should refer to the Finance Act version of the article (to be published on the ACCA website in 2017).

So far in this article we have compared trading as an unincorporated trader with trading through a company by reference to the various relevant taxes and we have reviewed the choice of year end for an unincorporated trader.

In this final part we will look at pre-trading expenditure and capital allowances.

Pre-trading expenditure
Expenditure incurred in the seven years prior to the commencement of trade is treated as having been incurred on the first day of trading. Where the first period of trading is the basis period for more than one tax year (as in Illustration 1 in Part 3 of this article), such expenditure, together with other costs (and capital allowances) of the first period will be counted more than once when calculating taxable profits – see Illustration 2 below.

Capital allowances
For the purposes of capital allowances, assets purchased for use in the business prior to the commencement of trading are treated as having been purchased on the first day of trading. Assets owned by the trader and brought into the business are treated as having been acquired for their market value at the time they are brought into the business.

The annual investment allowance is increased/reduced for trading periods of more/less than 12 months. Accordingly, the length of the trading period in which significant capital expenditure is incurred can have an effect on the speed with which a business obtains relief for its capital expenditure.

Illustration 2
Irina began trading on 1 January 2016. In December 2015 Irina spent £160,000 on equipment for use in her business.

The capital allowances claimed by Irina will depend on the date to which she prepares her first set of accounts. It should be noted that the AIA limit for exams in the period 1 September 2016 to 31 March 2017 is assumed to continue to be £500,000.

Accounts prepared to 31 March 2016

 Main pool
£
Allowances
£
 
Period ended
31 March 2016
   
Additions qualifying for AIA

160,000

  
AIA (maximum £500,000 x 3/12)


(125,000)


125,000

 
 

35,000

  

WDA (18% x 3/12)

(1,575)

1,575

 
 

33,425

126,575

 

Period ending
31 March 2017

   

WDA at 18%

(6,017)

6,017

 

Tax written down value carried forward


27,408

  

Total allowances for the first two trading periods

 

132,592

 


Accounts prepared to 30 September 2016

 

Main pool
£

Allowances
£

 

Period ended 30 September 2016

   

Additions qualifying for AIA

160,000  

AIA (maximum £375,000
(£500,000 x 9/12))

(160,000)160,000 

Tax written down value carried forward

––  
 _______  

Period ending 30 September 2017

   

No tax written down value brought forward

–––– 
  _______ 

Total allowances for the first two trading periods

 160,000 


The effect of the accelerated capital allowances becomes more marked when the basis of assessment rules are applied to the tax adjusted profits of the business as, with a 30 September year end, the profits of the first nine months (as reduced by the capital allowances) form part of the calculations of the taxable profits for the first two tax years.

Illustration 3
Continuing from Illustration 2, Irina’s business has tax adjusted trading profits, before deduction of capital allowances, of £50,000 per month.

If Irina adopts a 31 March year end, her taxable trading income for the first two tax years of trading would be calculated as follows.

 £ 
1. Profit for each trading period
Three months ended
31 March 2016
((£50,000 x 3) – £126,575)  



23,425
 
Year ending 31 March 2017
((£50,000 x 12) – £6,017)

593,983
 
   
2. Taxable profit for
each tax year
  
2015/16 (1 January 2016 to
5 April 2016)
23,425 
2016/17 (Year ending
31 March 2017)
593,983 
Total taxable profits for the first two tax years617,408 


If Irina adopts a 30 September year end, her taxable trading income for the first two tax years of trading would be calculated as follows.

 £ 
1. Profit for each trading period
Nine months ended
30 September 2016
((£50,000 x 9) – £160,000)



290,000
 
Year ending
30 September 2017
(£50,000 x 12))


600,000
 
   
2. Taxable profit
for each tax year
2015/16 (1 January 2016
to 5 April 2016)
3/9 x £290,000




96,667
 
2016/17 (1 January 2016 to
31 December 2016)
£290,000 + (3/12 x £600,000)


440,000
 
Total taxable profits for the first two tax years
536,667
 

The difference between the total taxable profits for the first two tax years of £80,741 (£617,408 – £536,667) consists of additional capital allowances as follows:

 £ 
2015/16
((3/9 x £160,000) – £126,575)
(73,242) 
2016/17
(£160,000 – £6,017)
153,983 
 80,741 

The speed with which the capital allowances are claimed and the effect of the opening years basis of assessment rules are both timing differences, as opposed to absolute savings. However, the difference can be significant as the timing difference may be considerable.

Conclusion

In order to be able to handle questions concerning an unincorporated trader:

  • You must be willing to stop and think before you start writing your answer in order to ensure that you identify the taxes that need to be referred to and the points that need to be made.
  • You must know the basis of assessment rules in respect of profits and losses and be able to apply them to situations where the profits vary on a monthly basis.
  • You must know the differences between an unincorporated trader and a company and take care that you apply the appropriate rules.


Note: The unincorporated trader is considered further in:

  • Taxation of the unincorporated business – the existing business for P6 (UK)


Written by a member of the P6 examining team

The comments in this article do not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content of this article as the basis of any decision. The authors and the ACCA expressly disclaim all liability to any person in respect of any indirect, incidental, consequential or other damages relating to the use of this article.