ACCA F6 FA09 Study Text 2010

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Chapter 5: Trading income

Amounts credited in the accounts that are not taxable as trading

income

 Income taxed under other assessment rules

 Exempt income

 Capital profits

6 Amounts credited in the accounts that are not taxable

as trading income

6.1 Income taxed under other assessment rules

In the adjustment of profit computation, the aim is to adjust the figure of net profit

recorded in the financial accounts and to identify the profit arising from the trading

activities of the business.

The figure of net profit in the accounts may include income receivable from non-

trading sources. It is therefore necessary to deduct any income credited in the

accounts that is not assessable as trading income. This includes items such as:

 interest income

 dividend income

 UK property income

 foreign income.

This income is then included separately in the individual’s income tax computation,

applying the assessment rules for that source of income.

6.2 Exempt income

The net profit figure may also include income receivable that is exempt from income

tax. This must be deducted in the adjustment of profit computation.

The main types of exempt income which could appear in the accounts of an

unincorporated business are:

 competition prizes, national lottery and premium bond prizes, betting winnings

 income from ISAs (Individual Savings Accounts)

 income tax repayment supplement.

6.3 Capital profits

Capital profits on the disposal of assets also need to be deducted in the adjustment

of profit computation, as these profits are not taxed as trading income. Capital

profits are either liable to capital gains tax or not taxable at all.

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Proforma adjustment of profit computation

 Detailed proforma adjustment of profit computation

7 Proforma adjustment of profit computation

7.1 Detailed proforma adjustment of profit computation

The proforma below sets out some of the adjustments that may be required to

calculate the figure of adjusted trading profit.

(W1) Proforma computation: Adjustment of proﬁt £

Net profit as shown in the accounts X

Add Items of expenditure charged in the accounts that are not

allowable for tax under the trading income rules

Capital expenditure (may be eligible for capital allowances) X

Legal or professional fees relating to capital expenditure

(including leases, except fees relating to the renewal of a short lease)

Depreciation/amortisation charges for non-current assets X

Loss on the disposal of a non-current asset X

Non-trade debt written off X

Political donations and subscriptions X

Charitable donations under Gift Aid X

Appropriations of profit by the owner X

Private expenditure by the owner X

Goods taken out of the business by the owner X

Professional fees in relation to tax advice X

Disallowable portion of lease rental on car with CO

emissions over

160 g/km

Gifts to customers

(if > £50 and no advertisement, or if a gift of alcohol, food or tobacco)

Fines and penalties X

Entertaining expenses (except entertainment of employees) X

Minus Amounts credited in the accounts that are not taxable as trading income

Income taxed under other assessment rules

(e.g. income taxed as property income, interest income)

(X)

Exempt income

(e.g. ISA interest, repayment supplement)

(X)

Capital profits (may be assessed as a chargeable gain instead)

(e.g. profit on the disposal of a non-current asset, profit on the sale of

shares etc)

(X)

Minus Amounts not credited in the accounts that are allowable for

trading income purposes

Allowable deduction for short leases (X)

Adjusted profits before capital allowances

Chapter 5: Trading income

Example

David runs a printing business. He produces accounts to 31 March each year. The

net profit for the year ended 31 March 2010 is £82,200 after taking account of the

following:

Notes

Stationery 1 9,200

Salaries and wages 2 109,000

National insurance 3 5,400

Depreciation 14,800

Repairs and maintenance 4 7,400

Gas, electricity, water 5,800

Royalties payable (gross) 5 4,000

Motor vehicle expenses 6 17,925

Hire of car for an employee 7 4,300

Bank overdraft interest and charges 3,900

Sundry expenses 8 2,300

UK dividends received 2,700

Bank deposit interest received 4,800

Notes

(1) During the year David had some stationery specially designed and printed by

the firm for his daughter’s wedding. David did not reimburse the business,

but the goods were taken out of stock in the accounts at their cost of £300. If

sold to a customer the stationery would have been invoiced at £450.

(2) Salaries and wages comprised

Staff wages (including £8,500 salary to David’s wife, who is

employed as a part-time administrator)

66,250

Salary to David 40,000

Staff Christmas party 450

Agency fees for hiring of temps 2,300

109,000

(3) National insurance includes Class 2 NICs of David at £125. The remainder of

this expense relates to the employer’s NI contributions on staff salaries.

(4) Repairs and maintenance include £3,100 relating to the repair of the office roof

following a violent storm and £2,000 relating to alterations needed for the

installation of a new printing press.

(5) Royalties of £4,000 (gross) were paid on 28 February 2010 to another printing

firm for the use of a logo on a customer’s product.

(6) Motor expenses consist of the following:

Running costs of staff cars 9,105

Running costs of David’s car 8,320

Loss on the sale of a car 500

17,925

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David’s annual mileage was as follows:

Miles

Home to work 3,500

Visits to customers and suppliers 4,500

Private journeys 12,000

20,000

(7) The hire car has a retail price of £24,000 and CO

emissions of 180 g/km. The

employee uses the car 30% for business purposes.

(8) Sundry expenses include £150 paid to a charity under the Gift Aid scheme and

a £20 donation to the local church appeal.

Required

Calculate David’s adjusted profit before capital allowances for the year ended 31

March 2010.

Answer

David – year ended 31 March 2010 Notes £

Net profit 82,200

Add Goods taken for own use

– profit on wedding stationery (£450 – £300)

150

Depreciation 14,800

Appropriations of profit

– Salary to David

40,000

– Class 2 NICs of David 125

Capital expenditure

– Alterations relating to the installation of the press

2,000

Motor expenses (15,500/20,000 × £8,320) 3 6,448

Loss on the sale of car 500

Disallowable portion of hire charge on employee’s car 4 645

Gift Aid donation 5 150

–––––––––––––––––––––––––––––––––

–

147,018

Minus Dividends received from a UK company (2,700)

Bank deposit interest received (4,800)

–––––––––––––––––––––––––––––––––

–

Adjusted profits before capital allowances 139,518

–––––––––––––––––––––––––––––––––

–

Notes

(1) The wages paid to David’s wife will probably be allowed as they appear to be

reasonable remuneration for the services provided to the business. However,

David’s salary and his personal national insurance contributions are not

allowable.

Chapter 5: Trading income

(2) The installation costs relating to the new printing press are capital-related and

are not allowable. However, capital allowances will be available on the cost of

the new printing press, including the installation costs.

(3) Ordinary commuting from home to work is deemed to be private mileage.

Therefore David’s total private mileage is 15,500 out of his total annual

mileage of 20,000.

(4) The disallowable portion of the hire charge of the car is £4,300 x 15% = £645.

(5) The Gift Aid donation is not allowable as a trading expense. The amount

charged in the accounts must be added to profit. If a basic rate taxpayer, no

further adjustment is required as basic rate tax relief will automatically be

obtained in paying the donation net of 20% tax. If a higher rate taxpayer, the

higher rate relief is obtained by extending the basic rate band by the gross

amount of the Gift Aid donation.

(6) The gift to the local church appeal will be allowable as a small donation to a

local charity.

(7) No adjustment is needed in respect of the royalties as they are regarded as a

trading expense.

(8) The examiner will normally just ask you to ‘calculate’ the adjusted profit

therefore there is no need to explain the reasons for your adjustments.

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Paper F6 (UK)

Taxation FA2009

CHAPTER

Capital allowances

–

plant and machinery

Contents

1 An overview of capital allowances

2 The definition of plant and machinery

3 The system of capital allowances for plant and

machinery

4 The main pool

5 The special rate pool

6 Cars

7 Short life assets

8 Capital allowances for unincorporated businesses

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An overview of capital allowances

 The primary aim of capital allowances

 The types of capital allowance available

1 An overview of capital allowances

1.1 The primary aim of capital allowances

Capital purchases and other capital-related expenditure, such as depreciation

charges and legal fees incurred in making purchases of capital items, are not

allowable deductions in the adjustment of profit computation. However, businesses

are able to claim capital allowances instead. Capital allowances can be thought of as

tax depreciation allowances.

The depreciation charges in the financial accounts are calculated on a subjective

basis. Depreciation charges are therefore not allowed as a deduction in calculating

trading income. Instead, tax relief is given for the purchase cost of certain non-

current assets and subsequent capital expenditure (such as extensions and

improvements) using a standardised set of rules for capital allowances.

The primary aim of the capital allowance rules is to give tax relief for the net cost of

non-current assets by means of deductions from the adjusted profits figure over one

or more accounting periods.

The net cost of a non-current asset means the actual cost of using the asset in the

business over its useful life, after taking account of any sale proceeds received. In

other words, net cost is the original cost less any eventual sale/disposal proceeds.

Capital allowances are calculated for each accounting period separately and

deducted in the calculation of the trading income assessment.

1.2 The types of capital allowance available

For the purposes of the examination, the only relevant rules for capital allowances

are those that apply to:

 plant and machinery (explained in this chapter), and

 industrial buildings (explained in the next chapter).

Chapter 6: Capital allowances – plant and machinery

The definition of plant and machinery

 The source of the definition of plant and machinery

 Case law

2 The definition of plant and machinery

2.1 The source of the definition of plant and machinery

Tax legislation does not provide a comprehensive definition of plant and

machinery.

Case law provides some guidance on items which have been held to be plant and

machinery in the courts in the past, and in recent years some of these decisions have

been brought into the tax legislation.

Statute law contains lists of some items of expenditure which are to be classified as

plant and machinery and others which are specifically not to be classified as plant

and machinery. However, statute law does not provide a formal all-inclusive

definition of plant and machinery.

Deciding whether or not an item is plant and machinery is important because the

capital allowances available on plant and machinery are more generous than the

allowances available on other types of asset. In some cases, if an item is not deemed

to be plant and machinery, there may be no allowances available.

2.2 Case law

From case law a key test, known as the functional test, has been applied to decide

whether or not an item is to be treated as plant and machinery.

The functional test looks at the role the asset plays in the business as follows:

 If the asset is apparatus with which the business is carried on (i.e. the asset

performs an active function and is used in the trade), it should be treated as

plant and machinery

 If the asset is the setting in which the business is carried on, the asset performs a

passive function in the business and should not be treated as plant and

machinery.

Applying this functional test, it should be clear that plant and machinery includes

the typical non-current assets used by a business such as motor vehicles, machines,

computers, office furniture, equipment, fixtures and fittings, and so on. It also

includes assets creating an atmosphere for the public appropriate to the business

(such as pictures and artefacts in a hotel or restaurant).

Paper F6 (UK): Taxation FA2009

The system of capital allowances for plant and machinery

 The different categories of plant and machinery

 Allowances available for plant and machinery

 Preparation of a capital allowances computation

 Proforma capital allowances computation – plant and machinery

3 The system of capital allowances for plant and

machinery

3.1 The different categories of plant and machinery

For the purpose of capital allowances, plant and machinery must be grouped into

different categories. This is because different rates of allowances are available for

different types of asset.

All items of plant and machinery are included in the general pool (sometimes

referred to as the main pool) unless they are:

 Expensive cars = cars costing more than £12,000 which were acquired before 6

April 2009

 Short life assets = plant and machinery, other than cars, with a useful life of less

than 5 years and for which an election has been made

 Private use assets = assets with an element of private use by the proprietor

 Integral features, long life assets, thermal insulation and cars with CO

emissions

of more than 160 g/km. These go into the special rate pool.

3.2 Allowances available for plant and machinery

The types of capital allowances available are as follows:

 Annual investment allowance: this is available in the accounting period in

which an asset is purchased

 Writing down allowances: these are available every accounting period

 First year allowances: these depend on the date on which an asset is purchased

 Balancing allowances and charges: these are only applicable on the eventual

disposal of an asset.

The rules for each allowance are explained in detail later in this chapter.

This text uses the following abbreviations:

 AIA = annual investment allowance

 WDA = writing down allowance

 FYA = first year allowance