Well done. You have completed this learning activity.

Fact pattern

You are consulted by Tom Potts who is leaving his current employment to set up a business as an IT consultant. Tom will operate initially as a sole trader. You have advised him on the terms of a standard form consultancy agreement. Tom also asks you about his income tax position in relation to his new business. Tom does not expect to generate any income other than that derived from his consultancy business.

The starting point is that Tom will be liable to pay tax on the taxable profits of his business.

Taxable profits are determined by calculating the income generated from trading activities, then deducting from that amount the deductible expenditure incurred by the business, together with any other sums deductible under tax legislation.

Income receipts must usually be recurrent or capable of recurrence. They should be distinguished from capital receipts. Therefore, money received from services provided or sales of stock-in-trade will be income: one-off receipts from capital items will be capital receipts.

Deductible expenditure must be of an income rather than a capital nature. In addition, it must have been wholly and exclusively expended for the purposes of the business.

Tom’s business will work on a 12-month accounting period. However, the business’s liability to tax will be assessed by reference to the tax year (which runs from 6 April to the following 5 April).

Tom’s business started in the tax year 16 – 17. As such three tax years have already elapsed, meaning that the opening year rules are irrelevant.

The ‘current year’ basis will be used for assessing tax. That is, tax will be assessed on the accounting period of Tom’s business which concludes in the tax year in question.

Tax will be levied at a rate of 20% or 40% depending on the taxable profits made in the accounting period in question. For the tax year 2019-20, the 40% higher rate band will apply to all taxable income in excess of £37,500 (taking into account Tom’s personal allowance of £12,500). An additional rate of 45% is then applied to any taxable income over £150,000.