Trading Profits

Table of Contents

Company Income

As with income tax, corporation tax, taxes, profits and earnings in accordance with rules which apply to each of a number of types of income. Broadly speaking, the rules applicable to trading income, professional services income, investment income, rental income and capital gains are identical to those applying to income tax and capital gains tax respectively for individuals but with modifications.

Corporation tax is charged on total income and capital gains. There are no credits or allowances of a personal or other nature equivalent to those for individuals. Certain types of credit including in particular double taxation credits and credits for withholding tax may be available.

The broad classifications of income for corporation tax purposes are

Irish trading income
income from professional services
interest received without deduction of tax from abroad
interest received net of deposit interest, retention and similar taxes
income from letting property

Dividend income from an Irish resident company is franked investment income and is deemed exempt in the hands of an Irish company.

As with income tax corporation tax applies differing rules to differing sources of income. Many of the rules are the same as those applicable to the category of income in the case of income tax. In this context, the various chapters on income tax issues are directly relevant.

Company Gains

Although capital gains tax is taxed as a single tax with corporation tax, it is still necessary to divide out a company’s income and capital gains and then further divide its income in accordance with the various rules that apply to different types of income.

The same principles that apply to the calculation of capital gains apply to companies with a number of adjustments. Most of the principles applicable to capital gains tax for individuals also apply to the capital gains elements of corporation tax in the case of companies. However corporation tax applies to total profits which covers income and almost all capital gains excluding those on development land.

Unlike the case with income tax, the tax rate on company capital gains is higher than that for trading income.

Trading Income

The principal category of profits is usually that referable to the profits of the company’s trade or trades. Trading profits and profits attributable to every trade, adventure or concern in the nature of a trade are taxed as a trade. The basis upon which a trade is said to exist is the same as that applicable in the income tax context.

The so called badges of trade laid down in caselaw and ultimately by a UK Royal Commission on Taxation, is still regarded as the classic guide as to whether or not a trade exists. See our income tax section on the issue of whether there is a trade.

Similarly, the considerations as to when a trade commences, and ceases are the same as in the case of income tax. Generally a trade commences once goods are being produced or services are being provided. Preparatory work such as the acquisition of premises would not be sufficient. Legislation in any event permits the deduction of pre-trading expenses incurred in the two years prior to commencement.

Finance Act 2023 amends the provisions that pre-trading expenditure is not treated as incurred, on commencement of a trade or profession, for the purposes of calculating a loss for set off against other income. The amendment clarifies that the restriction also applies when calculating losses which may be set off in accordance with other provisions which relate to the set off of losses against other income taxable at the corporation tax rate of 12.5 per cent, on a value basis or which could be surrendered as group relief. The amendment applies to accounting periods commencing on or after 1 January 2024.

Exclusions

Non-trading income must be removed in the calculation of trading profits. A distinction is made between trading and investment income. Likewise, expenses must have been wholly and exclusively incurred for the purpose of the particular trade in order to be deductible. If the income is not linked to the trade concerned, it may be categorized under one of the other headings.

A trade wholly carried out outside the State is categorised in a different case to Irish trading income. Losses from such a trade may only be set off against profits of that foreign trade or by concession to other income in the same category. Where a trade is carried on partly abroad and partly in Ireland it is generally treated as an Irish trade.

The generation of income from an asset such as renting property, licensing intellectual property would not generally be sufficient to constitute a trade. However depending on the circumstances where there is a greater level of activity, for example, use of resources, marketing, employees etc there is an increased possibility that it may be categorised as a trade. Income from land situate in Ireland is always subject to special rental profit rules.

Ascertaining Income

Income from a trade or profession are calculated in accordance with the Companies Act and accounting practice statements. The adjustments applicable to income tax apply in most cases.

The question of whether or not there is a trade is determined in accordance with the same principles as apply to income tax. This can often be a critical matter. Trading implies a certain continuity. Mere occasional transactions are more likely to be categorised as investments subject on realisation to capital gains tax.

As in the income tax context, trading is defined as including every trade, manufacture adventure or concern in the nature of trade. This means that one-off and occasional transactions may potentially be subject to income tax in particular contexts.

Badges of Trade

Resort is usually had to the “badges of trade”. These are features identified in case law as characteristic of a trade. They include following

whether the particular activity is usually the subject of trading transaction
the period of ownership; shorter indicative of trade; longer indicative of investments
frequency and number of transactions; is trading is usually recurrent
Has the person undertaken work or incurred expense to realise the assets; indicative of trading
Reason for sale; motivation to raise cash for one-off reason less likely to constitute trade
Objective and purpose trading or investment in nature
Nature of finance arrangements (e.g. working capital v long-term capital)
Relationship to other trades carried out by individual

Income Receipts

If there is a trade the next question is whether the income arises from or relates to the trade. It may be a capital receipt in which event, it is not subject to income tax treatment and may be subject to capital gains tax treatment. It may be categorised as another source of income, taxable under one of the other headings. It may include for example, investment and rental income as well as distributions from companies.

Whether or not a receipt is income or capital in nature raises similar issues to whether or not there is a trade. The particular circumstances matter. What is a capital receipt in one business may be an income receipt in another.

Relevant factors include

How is it treated in the accounts?
Why has the receipt arisen?
Is it from a trade or from disposal of an asset?
How long has the asset been held?
Is the value significant relevant to the value of other income of the trade?
Did the asset comprise part of the long-term capital or profit-making elements of the trade?
Was it stock?

In some circumstances it may be important to determine whether the income is from one particular trade or another. Some trades qualify for exemption or favourable treatment.

Generally, receipts will be in money. However this will not necessarily be the case. Where an asset is received by way of payment for a sale, its value will generally be taken as income.

Assessment Period

The assessment is made with reference to an accounting period which is usually 12 months. It determines the cycle of payments of preliminary tax final tax and the date for making tax returns. It is not linked to the annual tax year in the same manner as applies to income tax. The relevant date can be changed subject to provisions which require adjustments.

The maximum accounting period is 12 months. Companies commonly adopt accounting periods that end on half yearly or quarterly dates such as 31st March 30th June 30th September or 31st December.

An accounting period ceases for the purpose of measurement of profits, one year after commencement or upon its accounting date if earlier. A new accounting period begins.

Therefore if the accounting period is more than 12 months, the profits and losses must be apportioned into two accounting periods.

A company can choose to change its accounting period. Revenue must be notified. It will affect the date on which preliminary tax obligations, corporation tax filing and final payment obligations arise.

Accounts

The starting point for corporation tax computation is the company’s financial accounts. Corporation tax is based on the company’s profits in the accounting period.

It is based on the profits the financial year and the rates of tax then in force. In the case of changes to the tax rate, apportionment may be required

Under company law and for tax purposes, company accounts are prepared in accordance with GAAP or IFRS standards of accounting practice. Listed companies in the EU prepare accounts in accordance with the International Financial Reporting Standards. GAAP represents generally accepted accounting practice.

Commencement of Trade

The general principles in relation to income tax apply in relation to the commencement of a trade. Commencement of trading is important as businesses commonly suffer losses at start up, which they wish to set against future profits. There is more limited scope for set off of pre-commencement expenses. See below.

Mere preparation to trade is not enough to constitute trading. However trading may commence before the first sale. It is dependent on the circumstances and the nature of the trade. For example, a complex manufacturing company may be regarded as trading where it purchases supplies involving a long lead-in time. In contrast a shop may not be regarded as commencing trading, until it opens or immediately before it opens.

Pre-Trading Expenses

Pre-trading expenses and charges (see later chapters on meaning) which are wholly and exclusively incurred for the purpose of a trade in the three years prior to its commencement are the deductible against the future profits of the trade. They are not allowed as a deduction against other income of the company.

A company may become subject to corporation tax when it first becomes resident in Ireland. See the chapter on residence and liability to corporation tax.

A company may become liable to income tax on its Irish source of income when it acquires that source. See the sections on income tax..

An accounting period ceases for the purpose of measurement of profits, one year after commencement or upon its accounting date if earlier. A new accounting period begins. Therefore if the accounting period is more than 12 months, the profits and losses must be apportioned into two accounting periods.

Cessation of trade

Cessation arises when the company ceases trading. It also arises when the company ceases to be resident in the State or ceases to be within the charge to corporation tax.

Cessation of trading does not occur until the business has fully sold off its stock and closed up.

Cessation of trade may arise when companies are merged or when businesses are transferred. A cessation may occur when one business / trade has wholly ceased, and another has commenced. This can happen where there is a very fundamental change in the nature of the business.

The accounting period is also deemed to end and a new one commences

when a resolution to wind up a company is passed
when a petition for winding up is presented (unless already on voluntary liquidation)
any other formal act commencing winding up