Taxation, EMPLOYMENT AND TRADING INCOME

Why is the distinction between employment and self-employment important?

Different tax rules apply. Self-employed individuals can claim a wider range of expenses and usually pay tax later than employees, creating potential tax advantages

What contract applies to an employee

A contract of service – income is taxed as employment income.

What contract applies to a self-employed person?

A contract for services – income is taxed as trading income.

What has HMRC been concerned about regarding employment status?

Individuals disguising employment as self-employment to reduce tax liabilities.

What are IR35 rules?

Anti-avoidance rules designed to prevent individuals from disguising employment by operating through personal service companies or managed service companies.

How does HMRC decide if IR35 applies?

By examining employment status indicators (e.g. nature of the contract and working relationship), though the list is not exhaustive.

What types of income are assessable as employment income?

• Wages and salaries

• Bonuses, fees, commission, tips

• Benefits in kind

• Certain termination payments

• Certain social security benefits

• Pensions

When is employment income taxed if payment is delayed?

Taxed on the earlier of:

1. The date the income is received, or

2. The date the employee becomes entitled to it.

When is a director treated as receiving employment income?

When the income is credited to the director’s account in the company records.

What is a trivial benefit in kind?

A benefit costing the employer £50 or less, which is exempt from tax.

How much employer-funded relocation expense is exempt?

Up to £8,000 of reasonable removal expenses.

Are employer pension contributions taxable?

No – employer contributions to registered pension schemes are exempt.

What non-cash gifts from third parties are exempt?

Non-cash gifts of £250 or less per tax year.

What home-working costs can be paid tax-free?

Up to £4 per week for additional household costs without evidence.

What termination payments are fully exempt?

• Lump sums from approved pension schemes

• Payments for injury, disability, or death

What termination payments are fully taxable?

Payments the employee is contractually entitled to (e.g. payment in lieu of notice).

How are ex-gratia termination payments taxed?

First £30,000 is exempt; excess is taxable as the top slice of income.

What is AMAP?

A tax-free mileage allowance for employees using their own vehicle for business purposes (not a company car).

What happens if AMAP paid exceeds HMRC rates?

The excess is taxable as employment income.

What if AMAP paid is less than HMRC rates?

The shortfall is an allowable deduction against employment income.

What expenses are automatically allowable by legislation?

• Occupational pension contributions

• Fees to approved professional bodies

• Payroll giving donations

• Travel and subsistence in performing duties

Are entertaining expenses allowable for employees?

No – unless reimbursed by the employer or offset against a specific entertaining allowance.

What is the key rule for claiming employment expenses?

Expenses must be incurred wholly, exclusively and necessarily in the performance of employment duties.

What legislation governs trading income?

The Income Tax (Trading and Other Income) Act 2005

Who do trading income rules apply to?

• Self-employed individuals

• Partners in a partnership

Can trading income arise from one-off transactions?

Yes. Trading income can arise from isolated or infrequent transactions of a trading nature

How does tax law define a trade?

‘‘Any venture in the nature of a trade” – a vague definition, so courts use indicators to decide.

Why are the Badges of Trade needed?

Because the definition of a trade is vague and disputes often arise over whether income should be taxed as trading income or capital gains.

What are the Badges of Trade?

Six key indicators developed by the courts to determine whether an activity amounts to trading.

How are the Badges of Trade applied?

No single badge is decisive; they are most effective when considered together.

What is meant by the “nature of the asset” badge?

Assets not normally held for personal enjoyment (e.g. commodities) are more likely to indicate trading.

What did Rutledge v CIR (1929) establish?

Even a single transaction can be trading if the nature of the asset suggests a profit-making motive.

How does the time between purchase and sale affect trading status?

A short period between purchase and sale suggests trading; long-term ownership suggests investment.

Why is processing or modifying an asset relevant?

Processing goods before sale indicates trading activity.

What did Cape Brandy Syndicate v CIR (1921) show?

Branding and recasking brandy before sale was evidence of trading.

How does the number of transactions affect trading status?

A pattern of similar transactions indicates trading, even if individual transactions appear capital in nature.

What did Pickford v Quirke (1927) establish?

Repeated similar transactions can together amount to trading.

Why is motive important in determining trading?

A profit-seeking motive strongly indicates trading activity.

What did Wisdom v Chamberlain (1969) show?

Borrowing funds for a short-term transaction with a view to profit indicated trading

How do circumstances of sale affect trading status?

Organised sales, advertising, or reinvesting proceeds into further assets suggest trading

When is there no presumption of trading?

When an asset is sold to fund an unexpected personal event

How is trading income assessed for income tax?

On income arising in the tax year (6 April – 5 April), aligning trading income with other income sources.

What major change took effect from 2023/24?

Trrading income is now assessed on a tax-year basis rather than accounting periods.

Why are most self-employed people unaffected by this change?

Because most already prepare accounts to 5 April or 31 March.

Are accounting profits the same as taxable trading profits?

No. Accounting profit is only the starting point; adjustments are required for tax.

What is the starting point for computing taxable trading profits?

Net profit per financial accounts

What items must be added back to accounting profit?

• Disallowed expenses (e.g. entertaining, depreciation)

• Capital expenditure

• Drawings

• Trading income not included in accounts

What items must be deducted from accounting profit?

• Non-trading income (e.g. bank interest, rental income)

• Income taxed under other rules

• Allowable expenses not in accounts

What is the result after all adjustments?

Profits adjusted for tax purposes (taxable trading profits).

What is the first question when assessing expenses for tax?

Is the item capital or revenue in nature? (capital items are excluded).

What is the “wholly and exclusively” rule?

Only expenses incurred wholly and exclusively for business purposes are allowable.

What is the remoteness test?

Expenditure too remote from the trade (e.g. childcare costs) is not allowable

What is the duality test?

If expenditure has both business and personal purposes, it is disallowed.