The issue of when a trade commences may be important. It determines dates of liability for tax and raises issues in relation to allowable expenditure. A distinction is drawn between trading and commencing to trade. Market testing and feasibility is likely to predate trading.
When assets are purchased in anticipation of trading, trading may not necessarily have begun. It depends on the circumstances. Where complex products are manufactured, trading may have commenced before the initial sale. In other cases there may be held to be no trading prior to the first sale.
The acquisition of business premises, securing of plant and equipment and supply lines may not commence trading. In contrast, the purchase of materials for manufacture may be sufficient to commence to trade. However, each case will depend on its circumstances.
The cessation of trade usually occurs when all stock has been disposed of. This may occur long after the decision to wind down or when winding down commences.
A trade carried on by an individual ceases on his death. There is a concession by which Revenue allows a surviving spouse to take over the trade and treat it as continuing
Posts cessation receipts are taxed under a different category in the tax rules. Expenses may be deducted, and unused allowances may be set against receipts.
Whether or not there has been commencement or cessation of trade is ultimately a matter of fact in the circumstances. If there is a radical change in the nature of the trade, there may be a cessation of one trade and the commencement of the other trade. There may be an overlap.
A cessation may arise where a trade is transferred or sold. Balancing charges or allowances may arise. Stock may become taxable, and an option may be available to postpone the liability.
Based on Accounts
Trading and professional income is assessed to tax by reference to business accounts, as adjusted under tax rules. The general rule is that the income tax on trading income is assessed on the basis of trading profits (or losses) for the 12 months’ accounting period ending in that tax (calendar) year. Therefore, if the trader’s year end is 31st January, then the basis of tax on trading income, for the year 2021 will be the accounts for the 12 month period ending 31 January 2021.
Where there is no accounts ending in the tax year, the tax is based on the profits for the whole year. The profits referable to be relevant period are apportioned to the 12 months concerned on a time basis. Where there is more than one set of accounts, the basis is the 12 month period ending on the later date in the tax year.
Where the accounting period is greater than 12 months, tax is based in the 12 months prior to the end of the accounting period. Once again, this involves apportioning the profits in the period on a proportionate time basis.
Commencement Years Basis
Where a trade commences, the first-year’s tax is based on the profits from the commencement date to the end of the year (31st December). When neither the trader nor his spouse (with joint assessment) carry out any other trade the due date for the return may be postponed to the second year to allow for the fact that accounts may not yet be prepared. The preliminary tax liability remains if applicable.
The second year’s tax is based on the 12 month period of accounts ending in the second year. If the period is for less than 12 months, it is based on the 12 months to that date.
If there are more than two periods of accounts, it is based on the 12 month period ending on the later date. If there is no accounting period in the second year of assessment and the trade commenced less than 12 months before the date on the second year the tax is based on the actual profits in the second year. If the accounts are apportioned, the assessable profit are apportioned by reference to the number of months.
In the third year, the normal basis applies The profits are based on the accounts for the 12 month accounting period ending in that year.
Because there may have been an overlap, the excess profits for the second year may be reassessed by reduction of the third year’s profits. The excess is the difference between the actual profits in the second year and the profits assessed in the second year.
If the originally assessed profits are greater than the actual profits the difference is the deduction against the third year profit. This may create a loss.
If in any given year there is no accounting period, the profits assessed and those for the actual calendar year. Where there are two or more periods of account, the profits are based on the 12 months to the latest accounting end date. Where the accounting period is for more than 12 months profits are based on 12 months to the end date for the accounts.
Accounting Date Changes
Where the accounting date is changed the prior year’s tax may be reviewed. If the profits for the new basis period is higher than for the original basis period, the excess is taxable
A business may decide to change its accounting date. Where there is more than one accounting period, the profits are assessed on the bases of the 12 months ending at the end of the later or latest accounting period. If there is no accounting period ending in the year, the profits are based on the actual profits of the tax (calendar) year.
It is necessary to recalculate the profit in the previous years on the basis of the new accounting period to include any additional liability. If the profits in the previous period on the basis of the new accounting year exceed those originally assessed, the previous year’s tax liability is revised.
Assessment on Cessation
Where a trade ceases, the tax is based on the profit in the final year, being the period from the beginning of the year to the date of the end of the trade. Because the previous year’s profits are based on the 12 month accounting period ending in that previous years, there needs to be an adjustment.
The assessment for the penultimate year is revised to the actual profits for the previous year. This adjustment must be included in the assessment for the last year. Any additional tax that may arise must be played at this point in time.
Where the trade ceases within three years of commencement the profits may be opted to be based on the actual profits earned as revised. The taxpayer can accordingly have the assessment of the second last year revised to the actual profits by law, the first and final year being taxed on this basis under the default rules.
Calculating the tax
Income tax is based on the profits of the business for the relevant year. This is ascertained by reference to the financial accounts for the relevant period, as set out above. Most commonly they will be based on the profits of the 12 month period expiring in the tax (calendar) year concerned.
Non- trading income is deducted in calculating the trading income. It is taxed separately under the relevant tax category heading (e.g. capital gain, investment income, rental income etc.)
Payments in kind will usually be treated as a receipt of value for what is received. The treatment will depend on whether they are effectively substituted income or capital in nature.
The financial accounts are adjusted so as disallow non-revenue, restricted or prohibited expenses. For example capital expenses and depreciation are excluded.
Personal, non-business expenses or a relevant proportion of them are added back. Expenses subject to special legislation such as motoring expenses or leasing are added back, and the adjusted amount is allowed..
There is no absolute test of what constitutes capital income (or gains) as opposed to revenue income. The sale of assets would generally be capital income. Revenue receipts would include payments in lieu of revenue payments.
Certain types adjustments are excluded such as changes in general provisions, but not in specific provisions for future losses, such as bad debts. It may be allowed, if justifiable under published accounting practices.
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