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).