Taxation of the unincorporated business for ATX (UK)

The new business
Part 4 of 4

This is the Finance Act 2020 version of this article. It is relevant for candidates sitting the ATX-UK exam in the period 1 June 2021 to 31 March 2022. Candidates sitting ATX-UK after 31 March 2022 should refer to the Finance Act 2021 version of this article (to be published on the ACCA website in 2022).

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 2021. In December 2020 Irina spent £385,000 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 to be used when sitting the ATX-UK exam in the period 1 June 2021 to 31 March 2022 is £1,000,000.

Accounts prepared to 31 March

 Main pool
£
Allowances
£
Period ended
31 March 2021
  
Additions qualifying for AIA

385,000

 
AIA (maximum £100,000 x 3/12)

(250,000)

250,000

 

135,000

 

WDA (18% x 3/12)

(6.075)

6,075

 

128,925

256,075

Period ending
31 March 2022

  

WDA at 18%

(23,207)

23,207

Tax written down value carried forward

105,718

 

Total allowances for the first two trading periods

 

279,282


Accounts prepared to 30 September

 

Main pool
£

Allowances
£

Period ended 30 September 2021

  

Additions qualifying for AIA

385,000 

AIA (maximum £750,000
(£200,000 x 9/12)

(385,000)385,000

Tax written down value carried forward

–– 
   

Period ending 30 September 2022

  

No tax written down value brought forward

––––
  _______

Total allowances for the first two trading periods

 385,000


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 £100,000 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 2021
((£100,000 x 3) – £256,075)  



43,925
Year ending 31 March 2022
((£100,000 x 12) – £23,207)

1,176,793
  
2. Taxable profit for each tax year 
2020/21 (1 January 2021 to 5 April 2021)43,925
2021/22 (Year ending 31 March 2022)1,176,793
Total taxable profits for the first two tax years1,220,718


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 2021
((£100,000 x 9) – £385,000)


515,000
 
Year ending 30 September 2022
(£100,000 x 12))

1,200,000
 
   
2. Taxable profit for each tax year
2019/20 (1 January 2021 to 5 April 2021)
3/9 x £515,000


171,667
 
2020/21 (1 January 2021 to 31 December 2021)
£515,000 + (3/12 x £1,200,000)

815,000
 
Total taxable profits for the first two tax years
986,667
 

The difference between the total taxable profits for the first two tax years of £234,051 (£1,220,718 – £986,667) consists of additional capital allowances as follows:

 £ 
2020/21
((3/9 x £385,000) – £256,075)

(127,742)
 
2021/22
(£385,000 – £23,207)

361,793
 
 234,051 

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 ATX (UK)


Written by a member of the ATX (UK) 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 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.