Trading profit, which is the income that HM Revenue and Customs (HMRC) will be taxing, is calculated by adding all the trade receipts of a business together, and deducting its expenses. Remember that not all expenses are deductible; if in doubt get professional advice or contact. Most receipts of a trade, such as those from sales can be easily identified, but others are more complicated. For example, money received on termination of a trading relationship as a token of personal appreciation would not be a trade receipt. However, money received on the cancellation of a trading contract as compensation would be a trading receipt.
In calculating trading profit, which is taxed, you can deduct expenditure that is:
It is easier to explain which expenses are of an 'income nature' by way of an example. Take the example of an antique dealer. The expenses to the dealer of buying stock are of an income nature and thereby deductible from trade receipts in calculating taxable profits. However, the expenses to the dealer of buying an antique desk for their office is of a capital nature and not deductible.
A useful test to determine whether expenditure is of an income nature is whether it is a recurring expense, rather than a once-and-for-all expenditure. All expenditure on electricity, telephone charges, staff salaries and interest on loans etc. are likely to be expenses of an income nature as they are incurred repeatedly.
Income tax on the profits of a trade is assessed under the following rules:
In the first tax year, income tax will be assessed on the profits made during that tax year, i.e. from the date of commencement to the following 5th April.
In the second tax year in which the trade is carried on, income tax will generally be assessed on the profits of the twelve-month accounting period which will normally start on the date you started your business.
In the final year, income tax will be assessed on the profits made from the end of the most recent accounting period to be assessed until the date the business ends. This will mean that the income tax will be assessed over a period of longer than twelve months. In order to compensate for this additional period you can make a deduction for what is described as 'overlap relief'.