Course notes

ICAEW Certificate Level

Principles of Tax
For exams in 2023

Tutor details
ii Introduction Principles of Tax

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Principles of Tax Introduction iii

Contents
Page

Introduction i

1 Introduction vi
2 Specification grid for Principles of Taxation vii
3 Studying at home? viii

1: Ethics 1

1 Fundamental principles 2
2 Ethical conflict resolution 3
3 Disclosure of information 3
4 Conflicts of interest 4
5 Anti-money laundering 5
6 Tax evasion v tax avoidance 7
7 Professional scepticism 8
8 Knowledge diagnostic 8

2: Introduction to taxation 9

1 Objectives of taxation 10
2 Liability to tax and tax administration 12
3 Sources of tax law and practice 14
4 Knowledge diagnostic 15

3: Introduction to income tax 17

1 Charges to income tax 18

2 Computation of taxable income 19
3 Computing tax payable 22
4 Marriage allowance 27
5 Knowledge diagnostic 28

4: Employment income 29

1 Calculation of assessable employment income 30

2 Taxable and exempt benefits 31
3 Pay As You Earn (PAYE) system 39
4 Knowledge diagnostic 42

5: Trading profits 43

1 Badges of trade 44
2 Adjustment to profits 45
3 Allowable and disallowable expenditure 46
4 Other adjustments 49
5 Knowledge diagnostic 50

6: Capital allowances 51

1 Introduction 52
2 Main pool: writing down allowances 53
iv Introduction Principles of Tax

3 Main pool: first year allowances 55

4 Annual investment allowance 55
5 Small plant and machinery pools 56
6 Cars and assets with private use 57
7 Balancing adjustments 58
8 Knowledge diagnostic 60

7: Trading profits – basis of assessment 61

1 Current year basis 62

2 Opening years 63
3 Overlap profits 65
4 Closing years 66
5 Partnerships 68
6 Knowledge diagnostic 69

8: National insurance contributions 71

1 Classes and payment of national insurance contributions 72

2 Class 1 NICs 72
3 Class 1A NICs 75
4 Class 2 NICs 76
5 Class 4 NICs 76
6 Knowledge diagnostic 78

9: Capital gains tax - individuals 79

1 Chargeable and exempt persons, assets and disposals 80

2 Computing a gain or loss 81
3 Capital gains tax payable by individuals 82
4 Chattels 84
5 Knowledge diagnostic 88

10: Corporation tax 89

1 Charge to corporation tax 90

2 Taxable total profits 91
3 Computation and payment of corporation tax 98
4 Knowledge diagnostic 101

11: Value added tax 103

1 The principles of value added tax (VAT) 104

2 Classification of supplies 105
3 Registration and deregistration 106
4 Output VAT 108
5 Input VAT 111
6 Knowledge diagnostic 113

12: Value added tax – further aspects 115

1 Accounting for VAT 116

2 Small business reliefs 118
3 VAT records and accounts 121
4 Knowledge diagnostic 122
Principles of Tax Introduction v

13: Administration of tax 123

1 Income Tax and Capital Gains Tax – returns and payment 124
2 Corporation Tax – returns and interest 128
3 Pay As You Earn (PAYE) – Real time information (RTI) 129
4 Value added tax – penalties and interest 131
5 The common penalty regime 134
6 Record keeping 137
7 Making Tax Digital for Businesses (MTDfB) 137
8 Compliance checks and appeals 138
9 HMRC Powers 139
10 Dishonest conduct by tax agents 139
11 Business Payment Support Service 139
12 Budget payment plans 139
13 Knowledge diagnostic 140

14: Solutions to interactive questions 141

Chapter 1 142
Chapter 2 142
Chapter 3 142
Chapter 4 146
Chapter 5 149
Chapter 6 149
Chapter 7 151
Chapter 8 153
Chapter 9 155
Chapter 10 157
Chapter 11 159
Chapter 12 160
Chapter 13 161
vi Introduction Principles of Tax

1 Introduction
1.1 What is the Principles of Taxation module and how does it fit within the
ACA Professional Stage?
There are 15 modules over three levels. These can be taken in any order with the exception of the
Case Study which has to be attempted last. You must pass every exam (or receive credit) – there are
no options. This ensures that once qualified, all ICAEW Chartered Accountants have a consistent level
of knowledge, skills and experience.

Certificate Level
There are six modules that will introduce the fundamentals of accountancy, finance and business. They
each have a 1.5 hour computer-based assessment which can be sat at any time. You may be eligible
for credit for some modules if you have studied accounting, finance, law or business at degree level or
through another professional qualification.
These six modules are also available as a stand-alone certificate, the ICAEW Certificate in Finance,
Accounting and Business (ICAEW CFAB). If you are studying for this certificate, you will only complete
the first six modules. On successful completion, the ICAEW CFAB can be used as a stepping stone to
studying for the ACA.
Principles of Tax Introduction vii

2 Specification grid for Principles of Taxation

2.1 Module aim
The aim of the Principles of Taxation module is to enable you to understand the general objectives of
tax and to calculate income tax, national insurance contributions, capital gains tax, corporation tax and
VAT in straightforward scenarios

2.2 Specification grid

This grid shows the relative weightings of subjects within this module and should guide the relative
study time spent on each. In each assessment, the marks available will equate to the weightings
below.
Weighting (%)
Objectives, types of tax and ethics 10
Administration of taxation 20
Income tax and national insurance contributions 26
Capital gains tax and chargeable gains for companies 10
Corporation tax 14
VAT 20
100

2.3 Method of assessment

Principles of tax will be assessed in a 1.5 hour exam. 20% of the marks are allocated from two scenario
based questions. These will each cover a single syllabus area:
 scenario one – income tax and national insurance contributions, and
 scenario two – corporation tax
The remaining questions will be multiple choice, multi-part multiple choice, numeric entry and
multiple response questions covering the remaining areas of the syllabus in accordance with the
weightings shown above.
The pass mark is 55%
viii Introduction Principles of Tax

3 Studying at home?
Accessing the First Intuition online content
This email will contain a link to FI Learn allowing you full access to the online content of the course. When
you access the link for the first time you will be prompted to create a password.
You will then have access to the recorded lectures, question debriefs, mock exams and step by step
guidance to help you succeed in the exam.

Before each lecture you will find a short narrative

providing useful guidance and emphasis on areas to
focus as well as recommended question practice to
confirm your understanding.
You can fast forward, rewind and pause. If you stop
watching a video it will restart where you stopped
next time. You can also speedup or slowdown the
video on the settings cog in the bottom right.

To track your learning there are Test your understanding questions at the end of each chapter and Progress tests at
regular intervals.
Finally, there are also mock exams to help you prepare leading up to the exam.
You should have received contact details of your personal tutor. Remember that they are only a phone call or email
away if you need any help or guidance, they are there to help every step of the way!
 1

Ethics

Topic List
1. Fundamental principles
2. Ethical conflict resolution
3. Disclosure of information
4. Conflicts of interest
5. Anti-money laundering
6. Tax evasion v tax avoidance
7. Professional scepticism
8. Knowledge diagnostic

Learning Objectives
 Identify the five fundamental principles given in the IESBA Code of Ethics for Professional
Accountants and ICAEW Code of Ethics, and the guidance in relation to a tax practice with
regard to:
– the threats and safeguards framework
– ethical conflict resolution
 Identify the following:
– conflicts of interest
– money laundering
– tax avoidance and tax evasion
 2 1: Ethics Principles of Tax

1 Fundamental principles
 The International Ethics Standards Board for Accountants (IESBA) sets robust, internationally
appropriate ethics standards for professional accountants worldwide.
 The ICAEW Code of Ethics (‘The Code’) is derived in part from the IESBA ‘Code of Ethics for
Professional Accountants’. In particular the five fundamental principles of professional ethics for
accountants appear in both.
 ‘Professional Conduct in Relation to Taxation’ (PCRT) has been produced by various accountancy
and taxation bodies including ICAEW.
 PCRT includes five standards designed to supplement the Fundamental Principles as set out in
‘The Code’.

Threats to the fundamental principles

Self interest

Intimidation
Advocacy
Self review

Familiarity

Safeguards
• Education/ training
• CPD
• Corporate Governance rules
• Professional standards
• Regulators
• External review

Fundamental Principles “Ibcop”

Integrity Be straightforward and honest in all business dealings
Professional Behaviour Comply with all relevant laws and regulations, avoid action which
discredits the profession
Professional Maintain professional knowledge and skill
competence and due Act diligently
care
Objectivity Avoid bias, conflict of interest or undue influence
Confidentiality Do not disclose information outside of business unless there is a
legal obligation to disclose
Principles of Tax 1: Ethics 3

1.1 Standards for tax planning

Professional Conduct in Relation to Taxation (PCRT) has developed five further Standards which
supplement rather than substitute the Fundamental Principles:
 Client specific
 Lawful
 Disclosure and transparency
 Advising on tax planning arrangements
 Professional judgement and appropriate documentation

2 Ethical conflict resolution

2.1 Conflict resolution process
When initiating either a formal or informal conflict resolution process, a professional accountant
should consider the following factors:
 relevant facts
 relevant parties
 ethical issues involved
 fundamental principles related to the matter in question
 established internal procedures
 alternative courses of action

Steps
 Consult with other appropriate persons within the firm, from the relevant professional body or
legal advisors.
 Obtain professional advice from professional body or legal advisor. The ICAEW runs a
confidential ethics helpline service for advice.
 Document issues and details of discussions held.
 If, after exhausting all relevant possibilities, the ethical conflict remains unresolved, a
professional accountant should, where possible, refuse to remain associated with the matter
creating the conflict.
 The professional accountant may determine that, in the circumstances, it is appropriate to
withdraw from the engagement team or specific assignment, or to resign altogether from the
engagement or the firm.

3 Disclosure of information
3.1 When to disclose
A professional accountant may disclose confidential information if:
 Disclosure is permitted by law and is authorised by the client or the employer
 Disclosure is required by law, e.g. under anti money laundering legislation
 There is a professional duty or right to disclose, when not prohibited by law e.g. to comply with
a review by a professional body or a regulator, or to protect the professional interests of a
professional accountant in legal proceedings.
 4 1: Ethics Principles of Tax

3.2 Factors to consider regarding disclosure

In deciding whether to disclose confidential information, professional accountants should consider the
following:
 Whether the interests of all parties, including third parties whose interests may be affected,
could be harmed if the client or employer consents to the disclosure of information by the
professional accountant
 Whether all the relevant information is known and substantiated, to the extent it is practicable
to do so
 The type of communication that is expected and to whom it is addressed
 Whether the parties to whom the communication is addressed are appropriate recipients
 Whether the information is privileged, for example under legal professional privilege
 The legal and regulatory obligations and the possible implications of disclosure for the
professional accountant

4 Conflicts of interest
4.1 The threat of a conflict of interest
A professional accountant shall take reasonable steps to identify circumstances that could pose a
conflict of interest.
A conflict may arise between the firm and the client or between two conflicting clients being managed
by the same firm, for example, acting for both a husband and wife in a divorce settlement, or acting
for a company and for its directors in their personal capacity.

4.2 Safeguards
Safeguards should ordinarily include obtaining the consent of both clients as well as some of the
following:
 Notifying the client of the firm's business interest or activities that may represent a conflict of
interest
 Notifying all known relevant parties that the professional accountant is acting for two or more
parties in respect of a matter where their respective interests are in conflict
 Notifying the client that the professional accountant does not act exclusively for any one client
in the provision of proposed services (for example, in a particular market sector or with respect
to a specific service)
The following additional safeguards should also be considered:
 The use of separate engagement teams
 Procedures to prevent access to information (e.g. strict physical separation of such teams,
confidential and secure data filing)
 Clear guidelines for members of the engagement team on issues of security and confidentiality
 The use of agreements signed by employees and partners of the firm to ensure actual and
perceived confidentiality
 Regular review of the application of safeguards by a senior individual not involved with relevant
client engagements
Principles of Tax 1: Ethics 5

If consent cannot be obtained or if the conflict cannot be reduced to an acceptable level the
accountant may not continue with both engagements. He must resign from one or both engagements.

5 Anti-money laundering
5.1 Introduction
Accountants are required to comply with the Proceeds of Crime Act 2002 (POCA) as amended by the
Serious Organised Crime and Police Act 2005 (SOCPA) and the Money Laundering Regulations
2007(the Regulations).
The ICAEW Members’ Regulations and guidance includes guidance issued by the Consultative
Committee of Accountancy Bodies (CCAB) in March 2018.
The ICAEW supports the UK Economic Crime Strategic Board (ECSB)’s 2019 Economic Crime Plan,
which has specific recommendations to the accountancy profession, including improving barriers to
information sharing and strengthening the role of Anti Money-laundering supervisory bodies (which
include the ICAEW).

5.2 Money laundering

KEY TERMS
Money laundering: The term used for a number of offences involving the proceeds of crime
or terrorist funds. It includes possessing, or in any way dealing with, or concealing, the
proceeds of any crime.
Proceeds of Crime Act 2002: POCA criminalises all forms of money laundering and creates
other offenses such as failing to report a suspicion of money laundering and ‘tipping off’.

Someone is engaged in money laundering under POCA where they:

 conceal, disguise, convert, transfer, or remove (from the United Kingdom) criminal property
 enter into or become concerned in an arrangement which they know, or suspect facilitates (by
whatever means) the acquisition, retention, use or control of criminal property by or on behalf
of another person
 acquire, use, or have possession of criminal property (e.g. the proceeds of tax evasion)
Criminal property: Includes (but not limited to):
 the proceeds of tax evasion, other tax-related offences, or any other crime
 a benefit obtained through bribery and corruption (including both the receipt of a bribe and the
income received from a contract obtained through bribery or the promise of a bribe)
 benefits obtained, or income received, through the operation of a criminal cartel
 benefits (in the form of saved costs) arising from a failure to comply with regulatory
requirements, where that failure is a criminal offense.
Tax related examples
Tax evasion consists of seeking to mislead HMRC by either:
 suppressing information to which HMRC is entitled, or
 providing HMRC with deliberately false information.
6 1: Ethics Principles of Tax

5.3 Failure to report

Where a professional accountant suspects that a client is involved in money laundering he should
report this to the National Crime Agency (NCA) in the form of a suspicious activity report (SAR).
If working within an accountancy firm he should make an internal report to his Money Laundering
Reporting Officer (MLRO) who will decide whether to submit a SAR to the NCA.
There are specific offences applying to MLROs for failing to make a report when one is needed and
several defences against a failure to report.

5.4 Tipping off

Once a report is made care should be taken not to tip off a money launderer, as this will constitute an
offence under POCA.

5.5 Anti-money laundering procedures

Businesses need to maintain the following procedures, in respect of all relevant business:
 Register with an appropriate supervisory authority (eg ICAEW)
 Appoint a Money Laundering Reporting Officer (MLRO) and implement internal reporting
procedures
 Train staff to ensure that they are aware of the relevant legislation, know how to recognise and
deal with potential money laundering, how to report suspicions to the MLRO, and how to
identify clients
 Establish appropriate internal procedures relating to risk assessment and management to deter
and prevent money laundering, and make relevant individuals aware of the procedures
 Carry out customer due diligence on any new client and monitor existing clients to ensure the
client is known and establish areas of risk
 Verify the identity of new clients and maintain evidence of identification and records of any
transactions undertaken for or with the client
 Report suspicions of money laundering to the NCA, using a suspicious activity report (SAR)
 Records of client identification need to be maintained for five years after the termination of a
client relationship by any part of the firm providing relevant business.

5.6 Client confidentiality in relation to money laundering

The money-laundering legislation requires an accountant to disclose confidential information without
client consent in certain circumstances. In order to disclose confidential information, the accountant
must have knowledge or suspicion, or reasonable grounds for knowledge or suspicion, that a person
has committed a money laundering offence.
Disclosure without reasonable grounds for knowledge or suspicion will increase the risk of a business
or an individual being open to an action for breach of confidentiality.

5.7 Penalties
Offences may be tried in a Magistrate's Court or in a Crown Court depending on severity. Cases tried in
the Crown Court can attract unlimited fines and the following terms of imprisonment:
 Up to fourteen years, for the main money laundering offences
 Up to five years, for the failure to report offence
Principles of Tax 1: Ethics 7

 Up to two years imprisonment for tipping off offences, or contravention of the systems
requirements of the Regulations

6 Tax evasion v tax avoidance

6.1 Introduction
 Tax avoidance is legal while tax evasion is illegal.
 Tax evasion can lead to prosecution for the taxpayer and possibly their accountant.

6.2 Tax evasion

Tax evasion is illegal and consists of seeking to deliberately mislead HMRC by either:
 suppressing information to which HMRC is entitled; or
 providing HMRC with deliberately false information.
Minor cases of tax evasion are generally settled out of court via the payment of penalties. Serious
cases of tax evasion, particularly those involving fraud, continue to be the subject of criminal
prosecutions which may lead to fines and/or imprisonment on conviction.
Furthermore, tax evasion offences will fall within the definition of money laundering and in certain
cases individuals may be prosecuted under one of the money laundering offences.
Thus, where an accountant is aware of or suspects that a client has committed tax evasion, he himself
may commit an offence under money laundering legislation if he has in any way facilitated the
evasion. Even if the accountant was not involved in the tax evasion itself, failure to report such a
suspicion is also an offence.

6.3 Tax avoidance

Tax avoidance is not defined but is broadly any legal method of reducing the tax burden. Despite
being legal this does not mean it is always acceptable.
In the past HMRC has responded to major tax avoidance schemes by changing legislation as the
scheme has come to its attention. However, there is a general presumption that the effect of the
changes cannot be backdated.
In recent years there has been a requirement for promoters of certain tax avoidance schemes to
disclose their schemes to HMRC, and for taxpayers to disclose details of which schemes they have
used. This may enable HMRC to take action more rapidly to close the loopholes.
The leading case in relation to tax avoidance schemes is Ramsay v IRC (1982). In Ramsay the House of
Lords established the doctrine that certain transactions can be disregarded if they are:
 preordained, i.e. virtually certain from the start that a chain of transactions will take place; and
 designed with the main aim of avoiding tax.
Later cases argued that transactions could be set aside only if they lacked commercial purposes.
However, this did not allow HMRC wide enough powers and a general anti abuse rule (GAAR) was
introduced which allows HMRC to challenge arrangements which have the avoidance of tax as their
main purpose.
 8 1: Ethics Principles of Tax

6.4 Tax advice

When giving Tax advice, a professional accountant should both understand HMRC’s position and
ensure compliance with the five Standards for Tax Planning set out in Professional Conduct in Relation
to Taxation (PCRT).

7 Professional scepticism
Professional scepticism is defined as an attitude that includes a questioning mind and would involve
being alert to conditions indicating possible misstatement due to fraud or error.
This will be particularly important where an accountant encounters potential cases of tax evasion or
money laundering.

8 Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you define the five fundamental ethical principles?

Do you know the different types of threats to the fundamental principles?

Can you list the steps required for ethical conflict resolution?

What are the usual safeguards implemented when a professional accountant faces
a conflict of interest?

What actions by a taxpayer would constitute tax evasion?

What are the three money laundering offences under the Proceeds of Crime Act?
 9

Introduction to taxation

Topic List
1. Objectives of taxation
2. Liability to tax and tax administration
3. Sources of tax law and practice
4. Knowledge diagnostic

Learning Objectives
 Identify the objectives of digitalisation of tax
 Identify the objectives of taxation in general terms of economic, social justice and
environmental issues, the range of tax opportunities open to the government and the relative
advantages of different types of tax in meeting the government's objectives
 Recognise the impact of external influences on UK tax objectives and policies
 Classify entities as individuals, partnerships, or companies for tax purposes and state how they
are taxed
 Identify who is liable for the following taxes, how the taxes apply to income and transactions,
identify the government bodies responsible for the taxes, and determine when an individual or
entity comes within the scope of the taxes:
– capital gains tax
– corporation tax
– income tax
– national insurance
– VAT
 Recognise the importance of the budget cycle, tax year and sources of UK tax law and practice:
– legislation
– case law
10 2: Introduction to taxation Principles of Tax

– HMRC manuals, statements of practice, extra-sta b tutory concessions, and press

releases

1 Objectives of taxation
1.1 Introduction
The purpose of this chapter is to provide background information which will assist your understanding
of the framework of the UK taxation system, why governments impose tax and the principles of
taxation.

1.2 Management of the economy

The government has an effect on the level of economic activity in the UK by its withdrawal of money
from the economy through taxation and the injection of money into the economy through public
sector spending.
More recently governments have believed the impact of taxation takes a long time to take effect and
moved to much longer term planning. the government has also delegated the setting of interest rates
to the Bank of England with specific inflation target rates.
The government also uses taxation to encourage or discourage certain types of economic activity.
The government encourages:
 savings, for example by offering tax incentives such as tax relief on pension contributions
 donations to charity, for example through the Gift Aid Scheme
 investment into business, for example through Venture Capital Trust relief and the Enterprise
Investment Scheme
 entrepreneurs who build their own businesses, through reliefs from capital taxes
The government discourages:
 smoking and alcoholic drinks, through substantial taxes on each type of product
 motoring, through vehicle excise duty and fuel duties

1.3 Social justice

Social justice lies at the heart of politics. Attitudes to the redistribution of wealth are a clear example.
The free market principal suggests that taxation should be minimal to encourage the economy to grow
whilst others suggest that the free market approach results in wealth being condensed in the hands of
a few.
There are a number of principles which either side might invoke in the debate over social justice:
 The direct/indirect principle
– direct taxes (eg. income tax, capital gains tax, corporation tax, national insurance
contributions) are only paid by those who generate the funds to pay the tax
– indirect taxes (eg. value added tax, excise duty) relate to consumption and it is up to
individuals whether they spend money on such goods. Indirect taxes also include stamp
taxes (eg. stamp duty, stamp duty reserve tax and stamp duty land tax).
 The progressive/regressive principle
– progressive taxes rise as a proportion of income as that income rises
– regressive taxes rise as a proportion of income as income falls
Principles of Tax 2: Introduction to taxation 11

 The unit/value principle

– a unit tax is calculated as a flat rate per item, regardless of value
– a value tax is based on a percentage of the value of the item
 The income/capital/expenditure principle
– income tax is paid only by those who generate income
– capital taxes are just because people should not be able to live off the sale of capital
assets without generating income. Capital gains tax and inheritance tax arise when
capital assets are disposed of or transferred (does not apply to companies)
– taxes on expenditure are paid only by those who incur the expenditure. These are
transaction-based taxes and include VAT and stamp taxes
 The ability to pay/benefit principle
– taxes should be based on the ability of the taxpayer to pay them e.g. income tax, capital
gains tax
– taxes should be based, at least partly, on the benefit that the taxpayer receives
 The neutrality principle
– tax should be neutral so as not to distort choice
 The equity principle
– tax should be equitable or just
 The efficiency principle
– the cost of collecting the tax should be low in relation to the tax raised

1.4 Environmental concerns

The taxation system is slowly moving to accommodate environmental concerns such as sources of
energy and global warming.
Many would agree that it is for the government to make sure that such concerns are dealt with
through government policy, including taxation, instead of leaving it to individuals to modify their
behaviour.
Examples of such taxes are:
 Climate change levy on businesses in proportion to their energy consumption
 Landfill tax to discourage the use of landfill sites for waste disposal and to encourage recycling
 Taxes on motor vehicles based on carbon emissions, such as cars provided to employees and
vehicle excise duty, to encourage use of more environmentally friendly vehicles

1.5 Other influences

 Devolved taxes
Devolution of legislative powers away from Westminster in favour of the Welsh and Scottish
governments has resulted in those parts of the UK operating different tax systems to those of
the rest of the country.

EXAM SMART
For the purpose of the exam you will only be expected to use tax rates and allowances which
apply to England.
12 2: Introduction to taxation Principles of Tax

 External influences
Recent external influences on UK taxes have included the EU and OECD (Organisation for
Economic Cooperation and Development).
The overall aim of the EU is the creation of a single European market with no internal trade
barriers and common policies relating to trade outside the EU.
There is no general requirement for member states to move to a common system of taxation.
However, states may provide for a common code of taxation within particular areas of their
taxation system.

Examples
Value added tax (VAT) where the UK whilst part of the EU was obliged to pass its laws to
conform to rules laid down by European law. There is a certain amount of flexibility between
the member states, for example on rates of taxation.
On 29 March 2017, Article 50 was triggered. On 31 January 2020 (exit day) the UK ceased to be
an EU Member State. However, exit day initiates an 11 month implementation period during
which the UK continued to be treated as an EU Member State for many purposes. The
implementation period ended on 31 December 2020 after which key domestic legal changes
associated Brexit took effect. This included the full repeal of the European Communities Act
1972, incorporation of retained EU law into the domestic legal regime and commencement of
the European Union (Withdrawal Agreement) Act 2020.
Further examples of external influences on UK taxation policy:
– the banking levy introduced to manage the risks on financial institutions
– the OECD’s model tax treaty which forms the basis of many UK international tax treaties
– the Coronavirus (COVID-19) led to emergency measures to attempt to mitigate the
impact of the pandemic on the UK economy.

2 Liability to tax and tax administration

2.1 Individuals
An individual may be liable to the following taxes:
 Income tax (IT), for example on income from investments, income from employment and
income from a business which he operates as a sole trader or as a member of a partnership
 Capital gains tax (CGT) on the disposal of capital assets owned by him as investments or used in
his sole trade or partnership
 National insurance contributions (NICs) as an employee, as a sole trader or partner, and as an
employer
 Value added tax (VAT) as the supplier of goods and services or as the final consumer of goods or
services
An individual is taxed annually on his income and gains arising in a tax year.

KEY TERM
Tax year: 6 April in one calendar year to 5 April in the next calendar year.
Principles of Tax 2: Introduction to taxation 13

2.2 Partnerships
A partnership is a group of persons carrying on a business together with a view to making a profit.
Each partner is liable to tax on his share of income and gains of the partnership in a tax year, but not
for tax on the shares of income and gains of the other partners.
The partners are jointly and severally liable to the following taxes:
 Income tax of employees deducted under the Pay As You Earn (PAYE) system
 National insurance contributions (NICs) as an employer (employer contributions and employee
contributions are collected under the PAYE system)
 Value added tax (VAT) as the supplier of goods and services or as the final consumer of goods or
services
'Joint and several' liability means that these taxes can be recovered from all or any of the partners.

2.3 Companies
A company is a legal person formed by incorporation under the Companies Acts. It is legally separate
from its owners (shareholders) and its managers (directors).
A company is liable to the following taxes:
 Corporation tax (CT) on its income and gains
 Income tax of employees deducted under the Pay As You Earn (PAYE) system
 National insurance contributions (NICs) as an employer (employer contributions and employee
contributions collected under the PAYE system)
 Value added tax (VAT) as the supplier of goods and services or as the final consumer of goods or
services
The rate of corporate tax is determined by reference to the financial year.

KEY TERM
Financial year: 1 April in one calendar year to 31 March in the next calendar year.

2.4 HM Revenue & Customs

Apart from some devolved taxes, His Majesty's Revenue & Customs (HMRC) administers most taxes in
the UK.
The responsibilities of HMRC are:
 to collect and administer IT, CGT, NIC, CT and VAT
 to pay and administer universal credit, tax credits and child benefit
 to collect repayments of student loans
 to ensure all employers meet the minimum wage rules
 to protect UK society from tax fraud, alcohol and tobacco smuggling and illegal importation of
drugs
14 2: Introduction to taxation Principles of Tax

2.5 Making Tax Digital for Businesses (MTDfB)

MTDfB is a government project which aims to provide UK businesses with a modern, streamlined
system to keep tax records up to date and provide accurate and timely information to HMRC.
Fundamental changes to the tax system will end the use of the tax return in its current form and will
aim to make tax administration more efficient, more effective and simpler for the taxpayer.
 Initially only applies to businesses for VAT purposes, with all VAT-registered businesses being
required to keep digital VAT records from April 2022.
 With effect from 2024/25 Making Tax Digital for income tax will apply to individuals with trading
or property income over £10,000 per annum, expanding to other taxes after 2024/25.

3 Sources of tax law and practice

3.1 Legislation
The basic rules of the UK taxation system are in a number of tax statutes (Acts of Parliament).
The tax legislation is amended each year by the Finance Act. This is based on proposals from the
Government put forward by the Chancellor of the Exchequer in the Budget speech. The Budget forms
the basis for the Finance Bill which becomes the Finance Act after Royal Assent is received.
The Finance Act generally relates to the tax year and financial year starting in April of that year. There
is usually one Finance Act for each tax year unless there is a general election when there may be more
than one budget and Finance Act.
Historically the Budget was held in March or April. From Autumn 2017 the UK moved to an Autumn
Budget. This allows tax changes to be announced well in advance of the start of the next tax year in
April.
Most of the statutory tax law is found in consolidated statutes which contain the law enacted by
Finance Acts over the years. For example, value added tax is dealt with in the Value Added Tax Act
1994 (VATA 1994).
The main direct tax law has been rewritten in plainer English. An example is the Corporation Tax Act
2010 (CTA 2010).
Some tax statutes provide for the making of detailed regulations by statutory instrument (SI). A SI
must be laid before Parliament and will usually automatically become law within a stated period
unless any objections are raised to it.
Delegated legislation (often called statutory instruments or regulations) add much of the detail to
statutes in this area.

3.2 Case law

Over the years, many thousands of tax cases have been brought before the courts where the
interpretation of statute law is unclear.
Decisions made by judges to resolve these cases form case law. Many judgments are precedent for
future cases which means that they must be followed unless superseded by legislation or the decision
of a higher court.
Knowledge of specific case names is not examinable.
Principles of Tax 2: Introduction to taxation 15

3.3 HMRC publications

HMRC must act according to tax law, but it has some discretion over how it applies the law. HMRC
therefore publishes details of how the law is to be implemented in practice, for example on its website
www.hmrc.gov.uk.
These publications have no legal backing but do provide information on HMRC's interpretation of the
law which will be adhered to unless successfully challenged by a taxpayer in the courts.
HMRC publications include:
 Manuals, primarily for the guidance of its own staff but also mostly available to taxpayers and
tax professionals on the HMRC website
 Statements of practice (SP) setting out HMRC's interpretation of tax legislation
 Extra-statutory concessions (ESC) which provide for a relaxation of the strict legal position to
resolve anomalies and relieve hardship. ESCs are gradually being either codified or withdrawn.
 Press releases and explanatory notes dealing with changes in tax law, for example Budget
proposals
 Leaflets which are mainly aimed at ordinary taxpayers and explain the tax system in non-
technical language

4 Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Do you know what types of activities the Government encourages through the use
of tax incentives, and which they discourage through heavy taxation?

Can you identify which taxes are direct and which are indirect?

To which taxes are partners in partnerships jointly liable?

Do you understand the purpose of Making Tax Digital for Businesses (MTDfB)?

When does a Budget speech usually happen, and what date(s) do the rules that
are announced usually come into force?
16 2: Introduction to taxation Principles of Tax
 17

Introduction to income tax

Topic List
1. Charges to income tax
2. Computation of taxable income
3. Computing tax payable
4. Marriage allowance
5. Knowledge diagnostic

Learning Objectives
 Recognise the main sources of taxable and non-taxable income
 Calculate the personal allowance available to an individual according to personal circumstances
including the marriage allowance
 Calculate total taxable income and the income tax payable or repayable for individuals
18 3: Introduction to income tax Principles of Tax

1 Charges to income tax

1.1 Taxable persons
Income tax is charged each year on:
 Individuals
 Trustees
 Personal representatives (executors and administrators)
Children who are under 18 are taxable persons in the same way as adults. However, if the income is
generated by a gift from a parent this income is treated as the income of the parent not the child if it
exceeds £100 per year.

1.2 Sources of income

Income can be broadly divided into two main types:
 Income which is chargeable to income tax – this may be called taxable income or chargeable
income
 Income which is exempt from income tax – this may be called non-taxable income or exempt
income.

1.3 Chargeable income

The main types of chargeable income are:
 Income from employment
 Income from trading
 Income from renting out property
 Income from investments such as interest on loans, bank and building society accounts
 Income from investments such as dividends
 Income from other sources (pensions income, some social security benefits, income from casual work)

1.4 Exempt income

Some income is specifically exempt from income tax including the following:
 Interest on National Savings Certificates
 Income (interest or dividends) from Individual Savings Accounts (ISAs, sometimes called NISAs)
including Junior ISAs
 Betting, competition, lottery, and premium bond winnings
 Some social security benefits such as housing benefit and child benefit
 Statutory redundancy pay
 Scholarships
 Income tax repayment interest
 Apprenticeship bursaries paid to individuals leaving local authority care
 Compensation payments made under ‘qualifying payments’ schemes such as the Windrush
Compensation scheme
Principles of Tax 3: Introduction to income tax 19

2 Computation of taxable income

2.1 Income taxed at source
Some income is received by the taxpayer net of tax, which means that tax is already deducted at the
source of the income. The most common form of income taxed at source is employment income.

Salary earned

Employee receives Employer pays

employment income income tax to HMRC
net of income tax on behalf of
(PAYE) employee

Employment income is received net of income tax deducted under the Pay As You Earn (PAYE) system.
This simplifies the collection of tax for HMRC. However, when working out the chargeable income you
must include any tax deducted at source and use the gross amount.

2.2 Income received without deduction of tax at source

The other sources of income are generally received without deduction of tax at source. This is called
income received gross and includes:
 Trading income
 Property income
 Most interest:
– Interest from banks and building societies
– Interest on government securities (gilt-edged securities or gilts) such as Exchequer Stock
and Treasury Stock
– Interest on National Savings and Investments (NS&I) Direct Saver and Investment
Accounts
– Interest on non-commercial investments, such as a loan between friends
 Dividends from UK and overseas companies

EXAM SMART
If income is received net of tax, then the gross amount (i.e. amount received plus the tax
deducted at source) should be included as chargeable income.
If income is received gross, this gross figure should be included as chargeable income.
20 3: Introduction to income tax Principles of Tax

2.3 Types of income

Income is assigned to one of three categories for income tax purposes:
 Non-savings income: Employment income (including pension income and some benefits),
Trading profits, Property income, Miscellaneous income
 Savings income: Interest from investments
 Dividend income: Dividends from UK and overseas companies
This is because there are different rates of tax for each type of income.

2.4 Personal allowance

KEY TERM
Net Income: The total chargeable income before deducting the personal allowance.
Taxable Income: Net income after deduction of the personal allowance (for the purpose of
the exam).

Every individual taxpayer who is resident in the UK is entitled to a personal allowance from birth.
The personal allowance for the tax year 2022/23 is £12,570.
The personal allowance is deducted from the different types of income in the following order:
(1) Non-savings income
(2) Savings income
(3) Dividend income
Individuals with an adjusted net income (ANI) of more than £100,000 have their PA reduced as follows:
PA X
Less: 1/2 (ANI-£100,000) (X)
Restricted PA XXX

The personal allowance will therefore be withdrawn completely where adjusted net income exceeds
£100,000 plus (PA × 2).
Principles of Tax 3: Introduction to income tax 21

INTERACTIVE QUESTION: TAXABLE INCOME

Charlotte receives the following income in 2022/23:

 Employment income £11,950
 Bank interest £1,625
 Dividends from UK companies £1,500
Requirement
What is Charlotte's taxable income for 2022/23?
SOLUTION

INTERACTIVE QUESTION: REDUCTION OF THE PERSONAL ALLOWANCE

Julia had net income of £110,000 in 2022/23.

Requirement
What is Julia’s personal allowance for 2022/23?
SOLUTION
22 3: Introduction to income tax Principles of Tax

3 Computing tax payable

3.1 Pro forma income tax computation
The pro forma income tax computation is as follows:
A Taxpayer
Income tax computation
Non-savings Savings Dividend
income income income
£ £ £
Income
Employment income X
Interest X
Dividends X
Property income X
X X X
Deductions:
Gifts of assets to charity/qualifying interest payments (X)
Net income before losses X
Losses (X)
Net income X X X
Personal allowance* (X)
Taxable income X X X

Tax
£

X
Less: tax reductions (for example, marriage allowance) (X)
Add: child benefit tax charge X

Income tax liability X

Less: tax deducted at source (PAYE) (X)
Income tax payable/repayable X / (X)

* NB the PA is reduced where an individual’s net income exceeds £100,000. The reduction is £1 for
every £2 that net income exceeds £100,000.

3.2 Computing income tax liability

Once taxable income has been computed, you can calculate the income tax liability. When calculating
the tax on the three types of income, the rates are applied to cumulative income and must be
calculated in the following order:
(1) Non-savings income
(2) Savings income
(3) Dividend income

KEY TERM
Tax liability: The total amount of income tax due from a taxpayer.
Principles of Tax 3: Introduction to income tax 23

3.2.1 Income tax liability on non-savings income

For 2022/23, the rates of income tax for non-savings income are as follows:
 First £37,700 of taxable income = basic rate band = 20%
 Taxable income between £37,700 and £150,000 = higher rate band = 40%
 Remainder over £150,000 = additional rate band = 45%

INTERACTIVE QUESTION: INCOME TAX LIABILITY ON NON-SAVINGS INCOME

Lois has employment income of £169,000 in 2022/23. This is her only source of income in this tax year.
Requirement
What is Lois's income tax liability for 2022/23?
SOLUTION
Lois
Income tax liability:
Non-
savings
income
£

Employment income
Net income
Less: PA
Taxable income

Tax

3.2.2 Income tax liability on non-savings and savings income

For savings income, in addition to the basic, higher, and additional rate bands, an individual also has a
savings starting rate band and a savings income nil rate band.
The starting rate band for savings income is £5,000 and the starting rate is 0%. This starting rate only
applies to taxpayers who have savings income falling in the first £5,000 of taxable income (after taking
account of any non-savings income) and will therefore not apply if taxable non-savings income exceeds
£5,000.
In contrast, the savings income nil rate band applies even if the taxpayer has other non-savings
income. The income tax rate on savings covered by the savings income nil rate band is 0%, the savings
nil rate.
24 3: Introduction to income tax Principles of Tax

For 2022/23 the savings income nil rate band is as follows:

 Basic rate taxpayer = £1,000 @ 0%
 Higher rate taxpayer = £500 @ 0%
 Additional rate taxpayer = NO savings income nil rate band
For the purpose of the allowance, deciding whether an individual is a basic rate, higher rate or
additional rate taxpayer will depend on the highest rate of tax if this allowance is ignored.
A taxpayer may be entitled to both the savings starting rate band and the savings income nil rate band.
If this is the case the savings income nil rate band will apply to the first amount of savings income
above any that falls in the starting rate band.
The savings income starting rate band and the savings income nil rate band do not exempt savings
income from tax but count towards the basic rate band.
For 2022/23, the rates of income tax for savings income can be summarised as follows:
 First £5,000 of savings income = starting rate band = 0%
 First £1,000/£500/£0 of savings income above starting rate band = savings income nil rate band
= 0%
 Taxable income up to £37,700 = savings basic rate band = 20%
 Taxable income between £37,700 and £150,000 = savings higher rate band = 40%
 Remainder over £150,000 = savings additional rate band = 45%

INTERACTIVE QUESTION: INCOME TAX ON NON-SAVINGS AND SAVINGS INCOME

Evie receives the following income in 2022/23:

 Property income £13,150  Building society interest £51,000
Requirement
What is Evie’s income tax liability for 2022/23?
SOLUTION
Evie
Income tax liability
Non-savings Savings
income income Total
£ £ £
Property income
Building society interest
Net income
Personal allowance
Taxable income
Tax
Principles of Tax 3: Introduction to income tax 25

3.2.3 Income tax liability on all income

Similarly to the savings income nil rate band, an individual has a dividend nil rate band. This is £2,000
for all taxpayers whatever their level of taxable income. Dividend income covered by the dividend nil
rate band is taxed at 0%, the dividend nil rate. There is no dividend starting rate.
For 2022/23, the rates of income tax for dividend income can be summarised as follows:
 First £2,000 of dividend income = dividend nil rate band = 0%
 Taxable income up to £37,700 = dividend ordinary rate band = 8.75%
 Taxable income between £37,700 and £150,000 = dividend upper rate band = 33.75%
 Remainder over £150,000 = dividend additional rate band = 39.35%

INTERACTIVE QUESTION: INCOME TAX LIABILITY ON ALL INCOME

George receives the following income in 2022/23:

 Employment income £33,795
 Bank interest £5,000
 Dividends from UK companies £12,000
Requirement
What is George's income tax liability for 2022/23?
SOLUTION
George
Income tax liability:
Non- Savings Dividend Total
savings income income
income

£ £ £ £

Employment income
Bank interest
Dividends
Net income
Less: PA
Taxable income

Tax
£
26 3: Introduction to income tax Principles of Tax

3.2.4 Computing tax payable/repayable

KEY TERM
Tax payable/repayable: The amount of income tax payable by a taxpayer (or repayable by
HMRC) under self-assessment after taking into account tax deducted at source.

The final stage that you may be asked to undertake is to compute the tax payable or repayable to the
taxpayer under the self-assessment system. Details of this system are covered later in these notes.
Tax deducted at source on employment income (PAYE) is used to reduce a taxpayer's tax liability to
calculate tax payable and any excess tax deducted at source can be repaid to the taxpayer.

INTERACTIVE QUESTION: INCOME TAX PAYABLE ON ALL INCOME

Elise receives the following income in 2022/23:

 Employment income £95,875 (PAYE deducted £17,575)
 Property income £31,700
 Bank interest £26,425
 Dividends from UK companies £17,000
Requirement
What is Elise's income tax payable for 2022/23?
SOLUTION
Elise
Income tax payable:
Non- Savings Dividend
savings income income
income

£ £ £
Employment income
Property income
Bank interest
Dividends
Net income
Less: PA
Taxable income

Tax
£
Principles of Tax 3: Introduction to income tax 27

3.3 Gift Aid

The Gift Aid Scheme gives tax relief for cash donations to charities.
An individual making a Gift Aid donation can receive income tax relief in 2 stages:
(1) Basic rate (20%) relief at source
(2) Higher/additional rate relief by extending the basic and higher rate bands by the GROSS
donation

INTERACTIVE QUESTION: GIFT AID

In 2022/23, Roz has business profits of £170,000 and makes a cash donation of £1,600 to charity under
the Gift Aid Scheme.
Requirement
What is Roz's income tax liability for 2022/23?
SOLUTION

4 Marriage allowance
4.1 Marriage allowance
In 2022/23, in limited cases a spouse or civil partner may elect to transfer up to £1,260 of their
personal allowance to their spouse/civil partner. This is only possible if:
 the transferor spouse must have no tax liability or be a basic rate taxpayer (after the PA
reduction)
 the recipient spouse must be a basic rate taxpayer
 relief is given by reducing the tax liability of the recipient at the basic rate.
Since January 2020, both marriage and civil partnership have been available to all couples in the UK,
irrespective of gender, and have legal status for tax purposes.
You should assume a taxpayer is single unless told otherwise.
28 3: Introduction to income tax Principles of Tax

INTERACTIVE QUESTION: MARRIAGE ALLOWANCE

Sally and her civil partner, Josie are both 40. In 2022/23 Sally has a part-time job earning £5,000 and
no other income. Sally made a marriage allowance election. In 2022/23 Josie had employment income
of £20,000.
Requirement
What is Josie’s income tax liability for 2022/23?
SOLUTION

5 Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you list the sources of exempt income?

Can you name three different types of taxable income and correctly categorise
taxable income items?

Do you know when an individual is entitled to a personal allowance, when and

how it is tapered, and where to deduct it in the income tax computation?

Can you apply the correct rates of income tax to the different types of taxable
income, including the savings and dividends nil rate bands?

Can you identify when a couple is entitled to the marriage allowance and
remember its effect?
 29

Employment income

Topic List
1. Calculation of assessable employment income
2. Taxable and exempt benefits
3. Pay As You Earn (PAYE) system
4. Knowledge diagnostic

Learning Objectives
 Calculate assessable employment income for an employee or director, including taxable and
exempt benefits
 Identify the key features of the PAYE system and calculate PAYE tax codes for employees
 Determine, in straightforward cases, due dates for employers' PAYE and national insurance
returns and payments
30 4: Employment income Principles of Tax

1 Calculation of assessable employment income

1.1 What is employment income?
Employment income includes income arising from an employment and the income of an office holder
such as a director.
In addition to salary this includes bonuses, commissions, reimbursed expenses, expense allowances,
inducements, tips and gratuities and any incidental benefits obtained by an employee (even if received
unsolicited from third parties).

1.2 Basis of assessment

The basis of assessment of general earnings is the receipts basis, which means the actual amounts
received in the tax year.
This is the earlier of:
 The time when payment is made
 The time when a person becomes entitled to payment

INTERACTIVE QUESTION: RECEIPT OF GENERAL EARNINGS

Thomas is employed as a car salesman at a monthly salary of £2,100. In addition to his basic salary, he
receives a bonus which is paid in May each year and relates to the sales made by Thomas in the year
to the previous 31 October.
His recent bonuses are as follows:
y/e 31 October 2021 Paid 1 May 2022 £2,250
y/e 31 October 2022 Paid 1 May 2023 £4,850
Requirement
What are the taxable earnings of Thomas for 2022/23?
SOLUTION
Principles of Tax 4: Employment income 31

2 Taxable and exempt benefits

2.1 The benefits code
Taxable benefits are set down in legislation called the benefits code.
Employees are subject to tax on benefits under the PAYE system, giving details of their taxable
benefits, including:
 Vouchers
 Living accommodation
 Expenses connected with the provision of living accommodation
 Cars and fuel for private use
 Vans provided for private use
 Assets made available for private use
 Any other non-monetary benefit provided by reason of the employment
Taxed on any benefits not specifically exempt (see below)
2 general rules to help later:
(1) Time apportion (on a monthly basis for the purpose of the exam) if not available for full year
(2) Deduct contributions made by the employee from the taxable benefit
Taxable benefits can be reduced to nil if the employee pays the full monetary value of the benefit to
the employer on or before 6 July following the tax year.

2.2 Vouchers
Employees are taxable on the provision of:
 Cash vouchers (vouchers exchangeable for cash) – the taxable amount is the sum of money for
which the voucher is capable of being exchanged
 Credit tokens (e.g. a credit card) used to obtain money, goods or services – the taxable amount
is the cost to the employer of providing the benefit, less any amount paid by the employee
 Vouchers exchangeable for goods and services (e.g. book tokens) taxable amount is the cost to
the employer of providing the benefit, less any amount paid by the employee

2.3 Living accommodation

Employees are taxable on the provision of living accommodation unless it is 'job related
accommodation'.
32 4: Employment income Principles of Tax

KEY TERM
Job related accommodation: Accommodation is job related if:
 the accommodation is necessary for the proper performance of the employee's duties
(eg caretaker); or
 the accommodation is provided for the better performance of the employee's duties
and the employment is of a kind in which it is customary for accommodation to be
provided (eg police officers); or
 the accommodation is provided as part of arrangements in force because of a special
threat to the employee's security (eg members of the government).

A director can only claim one of the first two exemptions if he owns 5% or less of the shares in the
employer company and either he is a full-time working director, or the company is non-profit making
or is a charity.

“Not job-related” accommodation

There are two potential benefits on the provision of living accommodation:

Basic rental benefit

The higher of:
(1) The annual value (given in question); and
(2) Any rent paid by the employer (employer doesn’t own property)

Additional yearly rent where property cost more than £75,000

This only applies to expensive accommodation which has been bought by the employer (i.e. NO rent
paid by the employer).
(Cost – £75,000) × the official rate of interest at the start of the tax year.
Cost = Original cost + improvements made before the start of the tax year in which the benefit is
charged.
Again, if the employee makes a payment to the employer for his occupation of the property then this
is deducted from the benefit.

The market value rule

If the property was acquired by the employer more than six years before it was first provided to the
employee, use the market value of the property when it was first provided instead of the original cost.

EXAM SMART
When calculating the value of a benefit such as accommodation look out for the facts in the scenario
that are relevant which may include for example:
 What was the date the benefit is provided?
 Did the employee make any contributions?
 If the employer purchased the accommodation how much did it cost and when was it
originally acquired?
Principles of Tax 4: Employment income 33

INTERACTIVE QUESTION: LIVING ACCOMMODATION

Kyle's employer provides him on 1 February 2022 with living accommodation consisting of a house
owned by the employer. The annual value of the house is £7,500. The house originally cost the
employer £150,000 and a conservatory was added at a cost of £15,000 in March 2022.
Kyle pays rent of £700 a month to his employer for use of the accommodation and occupies the house
throughout 2022/23. The official rate of interest on 6 April 2022 is 2%.
Requirement
What are Kyle's taxable benefits in respect of the living accommodation in 2022/23?
SOLUTION

2.4 Expenses connected with the provision of living accommodation

In addition to the living accommodation benefits described above, employees are also taxed on
related expenses paid by the employer such as:
 Heat and lighting
 Council tax and water
 Cleaning, repairs, maintenance and decoration
The taxable benefit is the cost to the employer less any employee contribution.
Where an employee is provided with furnished living accommodation, the employee will also have a
taxable benefit for the private use of the furniture provided by his employer (see the “20% rule” later
in this chapter).

2.5 Cars and fuel for private use

There is a taxable benefit on the provision of a car which is available for private use by the employee.
Private use includes home-to-work travel.
There is no taxable benefit for incidental private use of a 'pool' car which is available for use by any
employee and which is not normally kept overnight at or near an employee's residence.
Time apportion if the car is not available for private use for 30 days or more.
34 4: Employment income Principles of Tax

Basis of the charge:

Reduce this if the employee
% × List Price = Taxable Benefit contributes to the running cost of
the car

For CO2 >75g/km: Includes accessories bought with car

CO2 – 75 = X (round down) +20% Accessories added later for < £100 are ignored
5 (+4% for diesels) Ignore discounts given to employer (always use
(-1% after 5/4/20) list price)
Maximum = 37% Deduct capital contributions of up to £5,000

Calculate the tax charge (details in tables)

CO2 emissions Relevant %
0 g/km 2%
1-50 g/km depends on electric range (see below)
51-54 g/km 15%
55-59 g/km 16%
60-64 g/km 17%
65-69 g/km 18%
70-74 g/km 19%
75-79 g/km 20%
75 g/km and above 20% add 1% every 5g/km (max 37%)
Supplement for diesels 4%*(max 37%)

* Cars that meet the Real Driving Emissions Step 2(RDE2, also known as Euro 6d) standard are exempt
from the diesel supplement.
Electric range (miles)
>130 2%
70-129 5%
40-69 8%
30-39 12%
<30 14%
Principles of Tax 4: Employment income 35

INTERACTIVE QUESTION: CAR BENEFIT

Darren is employed on a salary of £25,000 per annum. He is provided with a car available for private
use during the whole of 2022/23. The car has a petrol engine and CO2 emissions of 98g/km. The car
has a list price of £13,395, but the employer only paid £10,395 for it after discounts.
Darren contributes £50 per month for its private use.
Requirement
What is Darren's taxable benefit in respect of the car?
SOLUTION

Fuel benefit
An additional benefit will apply where the employer pays for fuel used during private journeys.
% (same as car benefit) × £25,300 = Taxable Benefit
There is no reduction in the benefit if the employee makes a partial contribution to the cost of
private fuel.

EXAM SMART
The starting point for the fuel benefit is to work out the relevant % as you would for the car
benefit. The on-screen tax tables will then provide you with the fixed fuel benefit which
should be applied to the relevant %.
 Time apportion the benefit if not available for complete year
 Do not deduct partial contributions towards the fuel
36 4: Employment income Principles of Tax

INTERACTIVE QUESTION: FUEL BENEFIT

Dilip is provided by his employer with a car for private use. The CO2 emissions of the car are 192g/km
and the car uses diesel and does not meet the RDE2 standard. The car was registered in 2018. Dilip is
required to pay a nominal amount of £30 per month towards the cost of private fuel.
Requirement
What is Dilip's fuel benefit?
SOLUTION

2.6 Vans for private use

Employees have a taxable benefit on the provision of a van available for private use. In this case,
private use does not include travel from home to work, as long as the employee is not allowed any
other private use that is more than insignificant.
The benefit is an annual amount of £3,600. If a van is provided for private use and has zero emissions
the taxable benefit is £nil.
There is a separate charge for the provision by the employer of fuel for private use of the van. The
benefit is an annual amount of £688.

2.7 Assets available for private use

A taxable benefit arises to an employee who is provided by the employer with an asset available for
private use (including use by the taxpayer’s family), e.g. TV, computer, camera, yacht, private jet!
The amount of the taxable benefit is the higher of:
(1) 20% x MV when first provided
(2) Rent paid by employer

Insignificant private use

No taxable benefit arises if the private use is not significant (for example using a computer (provided
for work during the daytime) during the evening).
If there is significant private use, calculate the benefit in full then apportion for non-business use.
Principles of Tax 4: Employment income 37

INTERACTIVE QUESTION: PRIVATE USE ASSETS

Maria is provided with the following assets by her employer which are available for private use:
Television (provided on 6 October 2022) costing £1,100
Computer (provided on 6 April 2022) costing £2,700 and used 75% for business.
Maria makes a contribution of £10 a month for private use of the television. Maria needs the
computer for her work when visiting clients’ sites and uses it to help her children research their
homework on the internet.
Requirement
(a) What are the benefits taxable on Maria for 2022/23 for private use of these assets?
(b) Would the position have been different if the computer had been used 45% (significant) for
private use?
SOLUTION

2.8 Other benefits

In most other situations, the taxable benefit is the cost to the employer of providing the benefit less
any amount paid by the employee for the benefit. Where benefits are provided in-house, the cost of
the benefit is the marginal cost (e.g. private school place to children of employees).
38 4: Employment income Principles of Tax

INTERACTIVE QUESTION: MARGINAL COST

Leonard is a teacher at a public school. He pays a reduced fee of £2,000 in 2022/23 for his son to
attend the school.
In 2022/23 the following figures relate to students attending the school.
Normal fee payable per student £3,500
Average cost per student, including a proportion of fixed overheads £2,800
Additional cost of an extra student, including extra writing books, food etc £1,500
Leonard's son is taking up a place that would otherwise not be filled.
Requirement
What is the taxable benefit for Leonard for 2022/23 in respect of the school place?
SOLUTION

EXAM SMART
Always double check whether the benefit has been available for the whole tax year.
Remember to time apportion the benefit and also deduct any employee contributions.

2.9 Exempt benefits

There are a number of benefits which are specifically exempt from the charge on employment income.
Exempt benefits include:
 Contributions by an employer to a registered pension scheme
 A trivial benefit ie a benefit costing less than £50 to provide, which is not cash or a cash
voucher, and which is provided for non-work reasons eg a birthday. There is an annual cap of
£300 in respect of such benefits when provided to certain directors
 Pension advice and associated tax planning available to all employees up to £500 per tax year
(above which the full amount is taxable)
 Childcare facilities run by or on behalf of an employer
 One mobile telephone (including smartphones) available for private use by an employee,
including all calls
 Free or subsidised meals in a canteen where such meals are available to all staff
 Annual social events paid for by the employer up to £150 (incl VAT) per head per tax year. If the
event cost more than £150 the whole amount is taxable not just the excess over £150. For
multiple events, any events that aggregately do not exceed >£150 a head will be exempt, and
any further events will be taxable in full. A staff party that is not an annual event (eg. a one-off
event/ celebration) is taxable in full regardless of costs.
Principles of Tax 4: Employment income 39

 Entertainment provided by a third party (e.g. seats at sporting/cultural events)

 Non-cash gifts from third parties up to £250 per tax year from the same donor
 Provision of a parking space at or near the employee's place of work
 Awards of up to £5,000 made under a staff suggestion scheme
 Work-related training courses
 Sports and recreation facilities available to employees generally but not to the general public
 Payments towards the additional costs of an employee working from home (up to £6 per week
more with documentary evidence)
 Personal incidental expenses (e.g. cost of telephone calls home) whilst the employee is required
to stay away overnight on business up to £5 per night in the UK, £10 per night abroad
 Works buses and subsidies to public bus services
 Travel expenses when public transport disrupted, late night journeys and where car sharing
arrangements break down
 Use of bicycles or cyclist safety equipment if made available to all employees
 Reasonable removal expenses (maximum £8,000) paid for by an employer for a new
employment position or on relocation
 Non-cash long service awards in respect of at least 20 years’ service, not exceeding £50 per year
of service
 Eye tests (required under H&S legislation) and glasses provided for employees who use VDU
equipment
 Health-screening assessment or medical check-up provided for an employee, by the employer
(maximum of one of each per tax year)
 Cost of officially recommended medical treatment to facilitate return to work after absence due
to injury or ill health (£500 per employee per annum)
 Vehicle battery charging facilities at or near place of work, where vehicle is used by the
employee and it is not a taxable car or van

EXAM SMART
Many of the above exempt benefits have monetary values, and you need to be certain that if
the monetary cap is exceeded whether the whole benefit or just the excess is taxable.

3 Pay As You Earn (PAYE) system

3.1 What is the PAYE system?
The aim of the PAYE system is to ensure that the correct amounts of income tax and national
insurance contributions are paid on cash payments to employees. Employers may also opt to collect
and pay to HMRC the tax on various benefits through the PAYE system (voluntary payrolling – see
later).
The PAYE system applies to all cash payments made to employees (e.g. salaries, bonuses) and also to
certain assets which can be readily converted into cash (e.g. gold bars, wine).
40 4: Employment income Principles of Tax

Income tax and national insurance contributions deducted under the PAYE system must usually be
paid to HMRC 17 days after the end of the ‘tax month’ to which they relate. The tax month runs from
the 6th day of one month to the following 5th day of the next month. Therefore, payment is required
by the 22nd of each calendar month.
Payments can be made quarterly instead of monthly where the average monthly total of the PAYE
income tax and national insurance contributions does not exceed £1,500.

3.2 PAYE codes

The calculation of the PAYE income tax deduction is based on 'tax codes'.
For each tax year, the employee receives a PAYE coding notice (Form P2) setting out the allowances
and deductions available to the employee in that year and the resultant tax code.
The tax code computation is as follows:
Allowances £ Deductions £
Personal allowance X Taxable benefits if not taxed X
through voluntary payrolling
Allowable expenses X Adjustment for underpaid tax X
Adjustment for overpaid tax X B
A

A – B = +ve?
Remove last digit and add a letter:
L = basic PA
N = £11,310 (less £1,260 as a result of marriage allowance election)
M = £13,830 (plus £1,260 as a result of marriage allowance election)

INTERACTIVE QUESTION: PAYE CODE

Katie earns £24,000 a year. She is entitled to a basic personal allowance. She also receives taxable
benefits of £4,795.
Requirement
What is Katie's PAYE code for 2022/23?
SOLUTION
Principles of Tax 4: Employment income 41

A – B = -ve?
Remove last digit
Deduct 1 (who makes this up?!)
Put K at the beginning

INTERACTIVE QUESTION: K CODE

Zack earns £18,000 a year. He is entitled to a basic personal allowance. He also receives taxable
benefits relating to living accommodation of £12,777.
Requirement
What is Zack's PAYE code for 2022/23?
SOLUTION

Since a K code means that an employee could be left with no taxable pay, the PAYE deducted on any
pay day cannot exceed 50% of the amount of actual cash pay on that day.
The code number can also reflect unpaid tax on income from earlier years. In this case, gross up the
unpaid tax using the taxpayer's estimated marginal rate of income tax and deduct the grossed up
unpaid tax from total allowances.
PAYE codes issued by HMRC may also take into account the income tax on the taxpayer's estimated
savings income and dividend income. For example, taxpayers who receive up to £10,000 per year in
dividends, and do not otherwise need to complete a self-assessment return, can request that the
associated income tax be deducted from their wages or pension through an adjustment to their PAYE
code.
42 4: Employment income Principles of Tax

INTERACTIVE QUESTION: UNPAID TAX

Brandon earns £14,000 a year and has no other sources of income. He is entitled to a basic personal
allowance. He has unpaid tax of £300 from previous tax years which is to be paid through the PAYE
system.
Requirement
What is Brandon's PAYE code for 2022/23?
SOLUTION

3.3 Real time information (RTI)

Employers are required to provide information to HMRC every time a payment is made to employees.
This means that HMRC can ensure that employees pay the correct amount of tax during the year. This
has reduced the number of PAYE forms required.
The information is sent online, integrated with the employer’s payroll software.

4 Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you explain the receipts basis for earnings?

Can you calculate the taxable benefit for non-job related accommodation?

Can you calculate the taxable benefits for a range of different types of car?

Can you list ten different exempt employment benefits?

Do you know how a PAYE code is derived, and how to adjust for under or overpaid
tax?
 43

Trading profits

Topic List
1. Badges of trade
2. Adjustment to profits
3. Allowable and disallowable expenditure
4. Other adjustments
5. Knowledge diagnostic

Learning Objectives
 Recognise the badges of trade
 Allocate given items of business expenditure as allowable or disallowable for tax purposes and
calculate adjusted trading profits of a sole trader or partnership using the accruals basis of
accounting
44 5: Trading profits Principles of Tax

1 Badges of trade
1.1 Is a trade being carried on?
A trade is defined in tax legislation as 'every trade, manufacture, adventure or concern in the nature of
trade'. (Not very helpful!)
It has therefore been left to the courts to interpret this definition and there are a number of decided
cases identifying a number of key factors in deciding whether an activity constitutes a trade. These are
known as the badges of trade. You will be expected to know the badges of trade and the facts of the
cases described below. No one factor is conclusive on its own.
The case names are not examinable.

Buy and sell at a profit

Is it a trading profit?

Apply the Badges of Trade

Trading Profit Capital Gain

Income tax/NIC Capital gains tax (unless
exempt) (Chapter 9)

Badges of trade – if present Explanation

Intention to make a profit Intention to make a profit suggests trading e.g. the purchase of silver
bullion as a hedging transaction.
Number of similar transactions A transaction which, by itself, might be regarded as of a capital
nature, may be treated as a trading activity if a number of similar
transactions are entered into. E.g. purchase and asset stripping of 4
companies in a row.
Nature of the asset There are three reasons for purchasing an asset:
For personal use (capital)
As an investment (capital)
For resale at a profit (which constitutes trading) e.g. 34,000,000 yards
of aircraft linen or 1,000,000 rolls of toilet roll
Connection with existing trade For example, a car mechanic selling a car is likely to be regarded as
trading
Changes to the asset If an asset is purchased and then subjected to a process before resale
to enhance its marketability, the sale is more likely to be regarded as
a trading activity. e.g. blending brandy before resale
Reasons for sale A person who is forced to sell an asset due to financial problems is
unlikely to be trading.
Principles of Tax 5: Trading profits 45

Badges of trade – if present Explanation

Source of finance If money was borrowed short-term to buy or improve the asset, this
indicates a trading activity, especially if the loan could only be repaid
by selling the asset.
Period of ownership A shorter period suggests trading
Method of acquisition An asset that is acquired by inheritance, or as a gift, is less likely to be
the subject of trade

2 Adjustment to profits
2.1 Introduction
If only it were as simple as copying the profit from a trader’s profit and loss account. UK tax law
requires the use of accounts drawn up under recognised accounting principles. But this is only the
starting point as the following adjustments will need to be considered for tax purposes.

2.2 Computing taxable trading profits

Overview of the adjustment to profit computation
£
Net profits per financial accounts X
Add disallowable expenditure/income not shown in accounts X
Less non-trade income in accounts/expenditure not in accounts (X)
Tax adjusted profits before capital allowances X
Less capital allowances (X)
Tax adjusted profit/ (loss) after capital allowances X/(X)

EXAM SMART
One of the scenario-based questions in the exam will require you to adjust the profits of a
business to arrive at taxable trading income. The above proforma will be used in such
requirements and a full understanding of this process will be needed both in this exam and
future studies.

Trading allowance
A trading allowance of £1,000 is available to individuals who carry on a trade. If trading receipts for an
individual (not partner) for a tax year are less than £1,000, those receipts are not taxable.
If the receipts are above £1,000 the individual has a choice between calculating their taxable trading
income in the usual way, using the accruals basis, or alternatively, by election, deducting deemed
expenses of £1,000 from the receipts with no further reduction for actual expenses. The election
applies to all of the individual’s trades and relates to a specific tax year.
46 5: Trading profits Principles of Tax

WORKED EXAMPLE: TRADING ALLOWANCE

Esme has receipts of £1,655 in 2022/23 from giving private tuition to students. Her allowable expenses
are £450 for the year.
Requirement
What are Esme’s taxable trading profits in 2022/23, assuming all beneficial elections are made?
SOLUTION
Esme’s trading receipts are more than the trading allowance so she can calculate her taxable trading
profits either by
 deducting allowable expenses from her receipts: £1,655 - £450 = £1,205; or
 by deducting the trading allowance of £1,000 from her receipts: £1,655 - £1,000 = £655:
In this case Esme would elect to deduct the trading allowance in 2022/23.

EXAM SMART
In the exam always assume that the trading allowance applies if the receipts do not exceed
£1,000, but if the receipts exceed £1,000 you should assume that no election to use the
trading allowance has been made, unless told otherwise.

3 Allowable and disallowable expenditure

3.1 General principles

KEY TERM
Allowable expenditure: Expenditure incurred wholly and exclusively for the purposes of the
trade, not specifically disallowed by legislation.

If there is a dual purpose for expenditure (e.g. lady barrister’s clothing), the whole of the expenditure
is disallowed. However, HMRC will allow a reasonable apportionment between business (allowable)
and private (disallowable) use e.g. motor expenses.
The examiner will expect you to know the following table.
Item Notes
Capital expenditure Capital expenditure is disallowable.
Distinguish between genuine repairs (revenue) and
improvements (capital).
Repairing newly acquired asset in dilapidated state =
capital
Repairs using industry standard materials (e.g. repair of
single glazed window to double glazed) = revenue
Principles of Tax 5: Trading profits 47

Item Notes
Depreciation Depreciation is disallowed. Therefore, so are profits and
losses on disposal.
Depreciation and losses on disposal – add back
Profits on disposal - deduct
Appropriation of profit (1) Sole trader drawings
(2) Excessive remuneration for family/friends
(3) Partners “salaries”
Goods for own use Effectively an appropriation of profit (see example
below)
General provision For example, bad debts or stock (a specific provision is
allowable)
Trade bad debt Allowable
Non-trade bad debts Disallowable (see example)
Entertainment Non staff entertaining – disallowed
Staff entertaining – allowable
Gifts The following gifts are allowable:
 Gifts to employees
 Gifts of trade samples (not for resale), limited to
one per customer per year
 Gifts to customers if they incorporate
(1) a conspicuous advertisement for the business
(2) are not food, drink, tobacco or vouchers
exchangeable for goods and
(3) the total cost per customer is no more than
£50
All other gifts are disallowable.
Donations and subscriptions Allow
 Small donations to local charities are allowable if
the gift enhances the public image of the trade.
 Subscriptions to trade and professional
associations
Disallow
 Donations to national charities
 Political donations
 Charitable donations under Gift Aid
Fines and penalties Disallow fines and penalties except parking fines
incurred by an employee on a business activity
Interest on late paid tax Disallowable
Interest on sums borrowed for the business Allowable
48 5: Trading profits Principles of Tax

Item Notes
Legal and Professional fees Legal and professional fees relating to capital
expenditure is disallowable (e.g. conveyancing,
architects, surveyor’s fees).
However, the following expenses relating to capital
assets are specifically allowable:
 Legal costs relating to the renewal of a short lease
(50 years or less)
 Costs of registration of a patent or copyright for
trade use
 Incidental costs of raising long-term finance
Irrecoverable VAT Allowed if the expenditure to which is relates is
allowable
Employment payments Earnings paid to employees are generally allowable.
(Must be paid within 9 months of the accounting
period).
 Include tax and NIC (employers and employees).
 Redundancy payments are generally allowable. (On
the cessation of trade, restricted to 3 times the
amount of statutory redundancy pay).
Pension scheme Employers’ contributions to a registered pension scheme
are allowable in the accounting period of payment
Car leasing and rental costs 15% disallowance:
 if emissions >50g/km for leases taken out from 6
April 2021 (1 April for companies)
 if emissions >110g/km for leases taken out
between 6 April 2018 and 5 April 2021 (1 April for
companies)
 if emissions >130g/km for leases taken out before
6 April 2018 (1 April for companies)
Note: exam questions will only test most recent dates
Private use of leased item A further proportion of the lease cost must be
disallowed where there is private use by the sole trader

3.2 Bad debts/leased cars

WORKED EXAMPLE: BAD DEBTS

The bad debts of Jack for the year to 30 April appear as follows:
£ £
Written off Balance b/f
Trade debts 1,274 Specific provision 1,185
Loan to former employee 180 General provision 1,225
Balance c/f
Specific provision 1,194 Trade debts recovered 123
General provision 1,260 Profit and loss a/c 1,375
3,908 3,908
Requirement
What adjustments are required to arrive at Jack’s taxable trading profits?
Principles of Tax 5: Trading profits 49

SOLUTION
The loan to the former employee has been written off. This is not remuneration as the employee has
left so the payment is disallowable and will need to be added back.
The increase in the general bad debt provision is disallowable – add back £1,260-£1,225 = £35

WORKED EXAMPLE: LEASED CAR

Douglas leases a car with a retail price of £14,200 and CO2 emissions of 151g/km on 1 June 2022. The
leasing cost is £1,960 up to 31 December 2022.
Douglas prepares accounts to 31 December.
Requirement
What is the disallowable amount which needs to be added back?
SOLUTION
As the CO2 emissions exceed 50g/km and the lease is taken out after 5 April 2021 there is a flat rate
disallowance of 15% × £1,960 = £294

A further calculation is needed where there is private as well as business usage of a leased car. 85% of
the business proportion of the leasing cost is allowed and the remainder is disallowed.

WORKED EXAMPLE: LEASED CAR AND PRIVATE USE BY SOLE TRADER

Jane leases a car with a retail price of £16,000 and CO2 emissions of 200g/km on 1 May 2022.
Jane uses the car partly for business and partly for private purposes. Business usage of 60% has been
agreed with HMRC.
Jane prepares accounts to 31 December each year. The leasing cost to 31 December 2022 is £1,600.
Requirement
What is the disallowed amount which needs to be added back?
SOLUTION
Allowable expenses 85% × £1,600 × 60% (business use) = £816
Disallowable expenses £1,600 – £816= £784

4 Other adjustments
4.1 Trading profits not shown in accounts
The main example of trading profit not shown in the accounts of the business arises when goods are
taken from the business by the owner for personal use.
The owner must be taxed on the profit he would have made if the goods had been sold at market
value.
50 5: Trading profits Principles of Tax

The adjustment will depend on how the transaction has been shown in the accounts:
 If nothing is recorded in the accounts, add back the selling price
 If treated as drawings at cost, add back profit

WORKED EXAMPLE: GOODS TAKEN FOR OWN USE

Max took some goods from his business with a selling price of £160.
The cost of the goods was £90.
Requirement
What adjustments are required if:
(a) the transaction is not recorded in the accounts: or
(b) the transaction has been treated as drawings of £90?
SOLUTION
(a) Add back selling price of £160
(b) Add back profit (£160-£90) = £70

Non-trading income in accounts

Any non-trade income in the accounts must be deducted.
Examples include rental income, profits on the disposal of fixed assets and investment income.

4.2 Expenditure not shown in the accounts

The most common expenditure not shown in the accounts is business expenditure paid personally by
the owner. Such expenditure is allowable and should be deducted.
Pre trading expenditure is deductible if it is incurred within 7 years of the start date and would
otherwise have been deductible.

5 Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you list and briefly describe seven badges of trade?

Can you reproduce the pro-forma computation for adjustment to profits?

Do you understand why a trader may use the trading allowance rather than actual
expenses?

Do you remember the main categories of disallowable expenditure and the

exceptions when expenditure is allowable?

Can you understand the different adjustments that may be required when a trader
takes goods from the business for personal use?
 51

Capital allowances

Topic List
1. Introduction
2. Main pool: writing down allowances
3. Main pool: first year allowances
4. Annual investment allowance
5. Small plant and machinery pools
6. Cars and assets with private use
7. Balancing adjustments
8. Knowledge diagnostic

Learning Objectives
 Calculate the adjusted trading profits after capital allowances on plant and machinery of a sole
trader or partnership
52 6: Capital allowances Principles of Tax

1 Introduction
1.1 What are capital allowances?
Capital allowances are tax allowable depreciation. They are available in respect of expenditure on
plant and machinery.
FUNCTION v SETTING

“With which” we “Within which” we

carry on a trade? carry on a trade?

Capital allowances No capital

available allowances available

Examples Examples
 Moveable partitioning  Ship used as a floating restaurant
 Dry dock  Stand at a football ground
 Swimming pool  False ceiling
 Light fittings to create ambience  Shop fronts
 Canopy at petrol station

1.2 Who is entitled to capital allowances?

Capital allowances are available to a sole trader, a partner in a partnership, or a company. Broadly
anyone who incurs capital expenditure on assets to be used for the purposes of a trade carried on by
that person (or company). Capital allowances are calculated for each period of account (not each tax
year) and must be claimed by the taxpayer who can decide how much to claim up to the maximum.

1.3 Acquisition cost

In most cases, you will simply be given a figure for the cost of the asset and will use this in your
computation.
The owner may bring personally-owned assets into the business (e.g. when a business starts). In this
case, use the market value of the asset when it is brought into the business.
If VAT is recoverable use the VAT exclusive price. On assets where VAT is not recoverable (e.g. cars)
capital allowances are calculated on the VAT inclusive price.

1.4 Disposal value

The general rule is that the disposal value (scrap value or compensation) is the sale proceeds of the
asset. However, this cannot exceed the original cost of the asset.
If the asset is given away or sold for less than market value, then the disposal value will be market
value on date of disposal.
Principles of Tax 6: Capital allowances 53

1.5 Overview of capital allowances on plant and machinery

Per accounting period
Private Use
FYA Main Pool Asset Allowances
£ £ £ £
TWDV b/f X X
Additions:
Low emissions car X
FYA @ 100% (X) X
–
Additions:
Other FYA (e.g.electric car
charging point) X
FYA @ 100% (X) X
–
Additions X
AIA (X) X

Disposals (X)
X
WDA @ 18% (X) (X) x % X
TWDV c/f X X

Total allowances X

Steps
 Identify how many columns you need
 Identify the periods of account required (note any short period of account)
 Add in tax written down value brought forward
 Record acquisitions and disposals:
 remember to restrict disposal proceeds to acquisition cost
 consider carefully whether to apply AIA or FYA
 Calculate WDA remembering to restrict for
– short periods of account and
– private use assets.
 Add capital allowances into the adjustment to profits computation

2 Main pool: writing down allowances

2.1 Assets in the main pool
Expenditure on assets in the main pool includes:
 All machinery, fixtures and fittings and equipment
 Vans, forklift trucks, lorries, motorcycles
 Cars with C02 emissions of not more than 50g/km for purchases on or after 6 April 2021 (110g/km
purchased on or after 6 April 2018) (1 April for companies). (See section on cars below).
54 6: Capital allowances Principles of Tax

2.2 Writing down allowance

A writing down allowance (WDA) is given on the balance of the main pool at the end of the period of
account.
The WDA is a percentage of the pool balance for a period of account. The WDA is 18% per annum
reducing balance. Certain assets are pooled in a ‘special rate pool’ and receive a lower rate, but these
are not within your syllabus.
If the period is longer or shorter than 12 months the WDA is increased or decreased accordingly.

INTERACTIVE QUESTION: WRITING DOWN ALLOWANCES

Tyrone started in business on 1 June 2022. He decided to make up his accounts to 31 December each
year. He makes the following acquisitions:
1.6.22 Brings Volvo car into business, market value £5,500 (actual cost two years ago £7,000) with CO2
emissions of 45 g/km
1.9.22 Buys Nissan car costing £6,500, with CO2 emissions of 43g/km
He makes the following disposals:
1.9.23 Sells Volvo for £4,000
1.11.23 Nissan car is involved in an accident and is scrapped. Tyrone receives compensation of £250.
Neither car is used for Tyrone's non-business journeys and neither car is a qualifying low emission car.
Requirement
Show the maximum capital allowances available for Tyrone’s first two periods of account.
SOLUTION
Principles of Tax 6: Capital allowances 55

EXAM SMART
It is useful to learn to construct a capital allowances computation in this way even though
your exam is computer marked and you do not have to show your workings. The proforma
helps to accurately calculate the allowances and is especially helpful with more than one
accounting period.

3 Main pool: first year allowances

3.1 What are first year allowances?
As its name suggests, a first year allowance (FYA) is given in the period of account in which the
expenditure is incurred.
A FYA is always given in full, regardless of the length of the period of account.

3.2 100% first year allowances

There is a 100% FYA for expenditure on:
 new and unused zero emission goods vehicles where expenditure is incurred on or after 6 April
2010 (1 April for companies),
 charging points for electric vehicles incurred between 23 November 2017 and 5 April 2023
(31 March 2023 for companies)
 new qualifying low emission cars, that are electrically propelled, or emit not more than:
– 0g/km of CO2 for cars purchased on or after 1 April 2021
– 50g/km of CO2 for cars purchased between 1 April 2018 and 31 March 2021
– 75g/km of CO2 for cars purchased before 1 April 2018

4 Annual investment allowance

4.1 Annual Investment Allowance
An Annual Investment Allowance (AIA) is available to a sole trader, partnership or company. It can be
used against qualifying expenditure, which includes most plant and machinery, except cars.
Date of expenditure Maximum allowance per annum
Expenditure incurred from 1 January 2019 – 31 March 2023 £1,000,000
Expenditure after 31 March 2023 £200,000 – will not be examined

 The allowance must be set against expenditure in the accounting period in which it is incurred.
 For accounting periods which are not 12 months long, the AIA is pro-rated up or down
accordingly.
 Any balance of expenditure incurred in an accounting period on which AIA is not given, is
eligible for WDA.
56 6: Capital allowances Principles of Tax

INTERACTIVE QUESTION: ANNUAL INVESTMENT ALLOWANCE

Jose has been trading for many years and makes accounts up to 31 December each year. His capital
allowances pool brought forward at 1 January 2022 is £6,560. He makes the following acquisitions and
disposals:
 1.6.22 Sells for £480 plant which cost £900 two years earlier
 24.8.22 Buys a printing press for £40,000
Requirement
What are the maximum capital allowances available to Jose for the year ended 31 December 2022?
SOLUTION

5 Small plant and machinery pools

5.1 WDA for small pools
If the balance on the main pool is less than £1,000 (adjusted for short periods of account) it can be
written off immediately, rather than at % per annum.
Principles of Tax 6: Capital allowances 57

6 Cars and assets with private use

6.1 Cars
Date of purchase Emissions Capital allowances
Main pool cars (not low emission):
6 April 2013 to 5 April 2018 130g/km or less Main pool 18%
(1 April 2013 to 31 March 2018 for companies)
6 April 2018 to 5 April 2021 110g/km or less Main pool 18%
(1 April 2018 to 31 March 2021 for companies)
On or after 6 April 2021 50g/km or less Main pool 18%
(1 April 2021 for companies)
Low emission cars:
1 April 2015 to 31 March 2018 75g/km or less FYA – 100%
1 April 2018 to 31 March 2021 50g/km or less FYA – 100%
On or after 1 April 2021 0g/km FYA – 100%

NO AIA !!!!!
Cars with CO2 in excess of 130g/km or those purchased before these dates are not within the syllabus,
and furthermore exam questions will only test the most recent rates (ie. cars purchased from 1/6 April
2021).

INTERACTIVE QUESTION: CARS

Gordon prepares accounts to 31 March each year and had a main pool balance of £7,600 brought
forward at 1 April 2022:
In May 2022 Gordon bought:
Car 1 with emissions of 49g/km at a cost of £16,000. The car was for business use only.
Car 2 with emissions of 0g/km at a cost of £10,300. The car was for business use only.
Requirement
What are the maximum capital allowances available to Gordon for the year ended 31 March 2023?
SOLUTION
58 6: Capital allowances Principles of Tax

6.2 Assets with private use by sole trader or partner

Each asset which is partly used privately by a sole trader or partner is kept in a separate pool. This is
because only the business element of the capital allowances can be claimed.

EXAM SMART
 The AIA, the FYA or WDA is still calculated in full and deducted from the single asset
pool.
 Restrict the allowance given to reflect the business use/ private use of the asset

INTERACTIVE QUESTION: ASSETS WITH PRIVATE USE

Jasper has been in business for many years making up accounts to 30 April each year. The only asset
he owns for capital allowances purposes is computer equipment which he uses 20% privately and has
a tax written down value at 1 May 2021 of £2,000.
On 1 August 2021, he buys a car with CO2 emissions of 42g/km for £16,000 which he uses 30%
privately.
Requirement
What are the maximum capital allowances that Jasper can claim for the year to 30 April 2022?
SOLUTION

7 Balancing adjustments
7.1 Introduction
Balancing adjustments are used to make sure that the correct amount of WDA are given over the life
of the asset.

7.2 Balancing charge

If too many capital allowances have been given on an asset over its lifetime, a balancing charge arises.
This might happen if an asset is sold for an amount in excess of its tax written down value.
£
TWDV b/f X
Disposal (proceeds limited to cost) (X)
Balancing charge (X)
Principles of Tax 6: Capital allowances 59

Points to note:
 Deduct from other capital allowances (so increase trading profits)
 Restrict if a private use asset
 Can happen to single asset pools and main pool at any time

7.3 Balancing allowance

If too few capital allowances have been given on an asset over its lifetime, a balancing allowance may
arise. This might happen if an asset is sold for an amount less than its tax written down value.
£
TWDV b/f X
Disposal (proceeds limited to cost) (X)
Balancing allowance X

Points to note:
 Add to other capital allowances (so reduce trading profits)
 Restrict if a private use asset
 Can happen to single asset pools at any time, but only in main pool when trade ceases
Remember that in the period a trade ceases, no AIAs, FYAs or WDAs are given, only balancing
adjustments.

INTERACTIVE QUESTION: BALANCING ADJUSTMENTS

Philip has carried on a trade for many years making up accounts to 31 March.
At 1 April, Philip had a main pool with a tax written down value of £6,250 and a Ford car with 20%
private use with a tax written down value of £10,000.
Within the following accounting period:
 Philip sold office equipment for £7,200 (original cost £10,000).
 Philip sold his Ford for £7,500. On the same day Philip bought an Audi with CO2 emissions of
35g/km for £17,500. The Audi also has 20% private use.
Requirement
What are the maximum capital allowances available to Philip for the year ended 31 March?
SOLUTION
60 6: Capital allowances Principles of Tax

8 Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you understand what makes an asset ‘plant and machinery’ for capital
allowance purposes?

Can you calculate WDA on the main pool?

Do you identify an asset that qualified for 100% FYA?

Are you able to apply the AIA correctly to expenditure incurred?

Do you understand the adjustments required for private use of an asset, and know
whether they apply to companies?
 61

Trading profits – basis of

assessment

Topic List
1. Current year basis
2. Opening years
3. Overlap profits
4. Closing years
5. Partnerships
6. Knowledge diagnostic

Learning Objectives
 Calculate the assessable trading profits for a new unincorporated business and identify the
overlap profits on the commencement of trade
 Calculate the assessable trading profits for a continuing business
 Calculate the final assessable trading profits for an unincorporated business ceasing to trade
 Allocate the tax-adjusted profits of a partnership to each partner and calculate the tax
assessable profits for each partner for any given tax year
 Calculate the adjusted trading profits after capital allowances of a sole trader or partnership
using the accruals basis of accounting
62 7: Trading profits – basis of assessment Principles of Tax

1 Current year basis

1.1 Basis periods and tax years
The fundamental problem facing a sole trader (and partnership) is that a tax return must be prepared
for a fiscal year (6 April to 5 April). However, a Profit and Loss Account may well have been prepared
for a different period altogether.
So, which profits are allocated to which fiscal (tax) year?
Current year basis tells us to:
 Tax the profits of the accounting period which ends in the fiscal year; and
 Try to tax 12 months profits (not always possible, see below)
The period which is taxable in a particular fiscal (tax) year is called a basis period.

INTERACTIVE QUESTION: BASIS PERIOD

Sasha has been trading for many years, making up accounts to 31 December each year.
Her recent taxable trading profits have been as follows:
 y/e 31 December 2021 £12,000
 y/e 31 December 2022 £15,000
Requirement
What is the amount of taxable trading profit assessable in 2022/23?
SOLUTION
Principles of Tax 7: Trading profits – basis of assessment 63

2 Opening years
2.1 Introduction
Special rules are needed for the opening years of a business. This is because there will not usually be a
12 month period of account ending in the tax year in which the business starts.

2.2 First tax year

The basis of assessment in the first tax year that a business operates is the actual basis. This means
that the taxable trading profits for the first tax year are the taxable trading profits of the business from
the date of commencement to the following 5 April.

2.3 Second tax year

The basis of assessment in the second tax year depends on the length of the period of account ending
in the second tax year. There are four possibilities:
Period of account ending in tax year Basis period
Less than 12 months long First 12 months of trading
12 months long That 12-month period of account
More than 12 months long 12 months to the end of the period of account ending
in the second tax year
No such period of account Actual basis (6 April to 5 April)

INTERACTIVE QUESTION: SECOND TAX YEAR

Ernest started trading on 1 January 2022. He decided to make up accounts to 31 December. His
taxable trading profit for the period of account for the year ended 31 December 2022 is £12,000.
Requirement
What are the amounts of taxable trading profits taxed in the first two tax years of trading?
SOLUTION
64 7: Trading profits – basis of assessment Principles of Tax

2.4 Third tax year

Usually, the current year basis applies to the third tax year of trading because there will be a 12 month
period of account ending in that tax year.
Occasionally, there will not be a 12 month period of account ending in the third tax year. In this case
the basis period will be the 12 months to the end of the period of account ending in the third tax year.

INTERACTIVE QUESTION: THIRD TAX YEAR

Sergio started trading on 1 February 2021. He decided to make up his accounts to 30 April each year.
Sergio has taxable trading profits of £30,000 for the 15-month period ended 30 April 2022 and £12,000
for the year ended 30 April 2023.
Requirement
What are the amounts of taxable trading profits taxed in the first three tax years of trading?
SOLUTION
Principles of Tax 7: Trading profits – basis of assessment 65

Summary of opening year rules

Yr 1: Actual (Start date – 5.4)

Yr 2: Is there an AP ending in the

fiscal year?

Yes No

How long is it? Actual (6 April – 5 April)

<12 months =12 months >12 months

Tax the 1st Tax the AP Tax the

12 months (ie CYB) 12 months to
the a/c date

Yr 3: Usually CYB possible (if not, tax 12 months to a/c date)

3 Overlap profits
You may have noticed that the way the opening year rules apply means that some taxable trading
profit may be taxed in more than one tax year.
Choosing a period of account which ends on a date other than 5 April will result in this double counting
and any trading profits taxed more than once are called overlap profits.
Overlap profits are carried forward to be relieved in the future, as we will see later in this chapter.
66 7: Trading profits – basis of assessment Principles of Tax

4 Closing years
4.1 Final tax year
The final tax year for a business is the tax year in which the business ceases to trade.
The basis period for the final tax year is from the end of the basis period for the penultimate tax year
to the date of cessation. In this year relief is given for overlap profits by deducting overlap from the
taxable trading profits.

4.2 Penultimate tax year

Usually, the current year basis will apply to the penultimate tax year (i.e. 12 month period of account
ending in the penultimate tax year).

INTERACTIVE QUESTION: FINAL TAX YEAR

Darren started trading on 1 May 2019. He chose to make up his accounts to 31 December each year
and had overlap profits of £5,000.
He had taxable trading profits of £10,000 for the year ended 31 December 2021.
Darren ceased trading on 30 November 2022. His final accounting period was the 11 months to
30 November 2022 and his taxable trading profits for that period were £6,000.
Requirement
What amounts of taxable trading profits are taxed in the final two tax years of trading?
SOLUTION
Principles of Tax 7: Trading profits – basis of assessment 67

INTERACTIVE QUESTION: OPENING AND CLOSING YEARS

Ian started trading on 1 August 2018. He chose to make up his accounts to 31 May each year.
Ian had the following taxable trading profits:
10 months to 31 May 2019 £24,000
y/e 31 May 2020 £31,000
y/e 31 May 2021 £44,000
Ian's business ceased on 30 April 2022. His taxable trading profits for the last eleven months of the
business were £38,000.
Requirement
Using the standard format below, show the amounts of taxable trading profits taxed in all tax years.
SOLUTION
First tax year (20...../.......)
Basis period .............. to ..............
£
Second tax year (20...../.......)
Basis period .............. to ..............
£
Third tax year (20...../......)
Basis period .............. to ..............
£
Overlap profits
Period of overlap .............. to .............. and .............. to ..............
Overlap profits
£
Penultimate tax year (20...../.......)
Basis period .............. to ..............
£
Final tax year (20...../.....)
Basis period .............. to ..............
Less: overlap profits
£
68 7: Trading profits – basis of assessment Principles of Tax

EXAM SMART
 It is important to follow a strict chronological order and structure for the calculations,
applying the correct rule for each year the business is in trade.
 In this example the entire life of the business is used, a quick check can be made to
ensure the sum of the profits allocated to the tax years matches the sum of the profits
for all the accounting periods.

5 Partnerships
5.1 How partners are taxed
A partnership is a collection of two or more individuals carrying on a business with a view to profit.

Steps when calculating a partner’s trading profit:

(1) Adjust the partnership profit (as for a sole trader)
(2) Calculate capital allowances for the partnership (as for a sole trader)
(3) Deduct 2 from 1.
(4) Allocate a share of the profit to each individual partner (see below)
(5) Treat each partner as a separate sole trader (i.e. CYB for continuing partners, opening year rules
for new partners, closing year rules for retiring partners)

5.2 Allocation of partnership profits

The taxable trading profits of the partnership are allocated between the partners according to the
profit sharing agreement for the period of account.
The agreement may specify that one or more of the partners is entitled to a 'salary' (in fact, simply an
allocation of profits) and/or interest on capital introduced into the partnership. These amounts should
be allocated first and then the remaining amount of taxable trading profits should be allocated in
accordance with the agreed profit-sharing ratio (PSR).

INTERACTIVE QUESTION: PARTNERSHIP

Erin and Cassandra have been in partnership for several years. The taxable trading profit of the
partnership for the year ending 31 March 2023 is £55,000.
The profit-sharing agreement for the partnership provides for Erin to be paid a salary of £10,000 a year
and Cassandra to be paid a salary of £15,000 a year. Any remaining profits are divided between Erin
and Cassandra in the ratio 2:1.
Requirement
What is the taxable trading profit for Erin and Cassandra for 2022/23?
Principles of Tax 7: Trading profits – basis of assessment 69

SOLUTION

EXAM SMART
You need to be particularly careful where there is a change in the profit-sharing agreement
during the period of account. The best way of tackling such questions is to divide the period
of account into the periods of the different profit sharing agreements. Make sure that you
time-apportion salaries and interest on capital.

6 Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Do you understand the current year basis and the circumstances in which it
applies?

Can you calculate the amount of profits to assess in the first two tax years of
trading for a range of different accounting reference dates?

Do you understand what overlap profit is and how to calculate it?

Can you explain what happens to taxable profits in the tax year that a trader
ceases to trade?

Do you know how the taxable profits of partners in a partnership are determined?
70 7: Trading profits – basis of assessment Principles of Tax
 71

National Insurance
contributions

Topic List
1. Classes and payment of national insurance contributions
2. Class 1 NICs
3. Class 1A NICs
4. Class 2 NICs
5 Class 4 NICs
6. Knowledge diagnostic

Learning Objectives
 Identify the key features of the PAYE and national insurance system
 Calculate the total national insurance contributions payable by employees, employers and self-
employed individuals
72 8: National Insurance contributions Principles of Tax

1 Classes and payment of national insurance contributions

1.1 What are national insurance contributions?
National insurance contributions (NICs) are paid by self-employed individuals, employees, and their
employers. The contributions are used to bear part of the liability of the government to pay state
benefits such as jobseeker’s allowance and state pensions and some state benefits will only be paid if a
minimum contribution has been reached. Anyone over 16 wishing to work in the UK must have a
national insurance number.

1.2 Classes and payment of national insurance contributions

National insurance contributions are administered by the National Insurance Contributions Office
(NICO) which is part of HM Revenue & Customs.
Class 1 Paid by employees and their Collected under the PAYE system on a monthly basis.
employers
Class 1A Paid by employers Payable electronically by 22 July following the end of the
tax year to which they relate.
Class 2 Paid by self-employed individuals Collected together with income tax under the self-
assessment system.
Class 4 Paid by self-employed individuals Collected together with income tax under the self-
assessment system.

2 Class 1 NICs
2.1 Introduction
Employee – Class 1 primary NICs.
Payments start on the employee’s 16th birthday and cease on reaching state pension age.

EXAM SMART
 State pension age is the age at which an individual is entitled to receive the basic state
pension and ceases paying NICs.
 Since October 2020 the state pension age for both men and women has been 66.

Employer – Class 1 secondary NICs.

Employers must pay Class 1 secondary NICs for all employees aged over 16, although the limits are
different depending on whether employees are aged 16 to 20, aged 16 to 24 and an apprentice, or
aged 21 and above. There is no upper age limit.
An employee’s earnings for Class 1 NIC purposes include all earnings received in monetary form:
salary, commission, bonus plus vouchers exchangeable for cash, goods or services (readily convertible
assets). Earnings do not usually include any taxable benefits and are calculated before allowable
deductions such as pension contributions.
See the tax tables for the current national insurance rates.
Principles of Tax 8: National Insurance contributions 73

In 2022/23 the primary threshold was increased part way through the tax year. As a result, in the
examination you will not be asked to calculate any annual Class 1 Primary NICs, only weekly or
monthly contributions using the primary threshold applicable for that specific period.
NIC is calculated by reference to an Earnings Period defined by the pay interval. Directors will have an
annual earnings period.
Note that there is a further threshold known as the Lower earnings limit (currently £6,396pa).
Employees paid at least this amount in a tax year accrue their entitlement to contributory state
benefits such as the state pension, although no NICs will be paid until their earnings exceed the
primary threshold.

INTERACTIVE QUESTION: CLASS 1 PRIMARY CONTRIBUTIONS

Meg is employed by Green Ltd and is paid weekly. She earns £424 in the first week of May 2022.
Munroe is also employed by Green Ltd and is paid monthly. He earns £4,800 in December 2022.
Requirement
What are the Class 1 primary contributions of Meg and Munroe respectively for these earnings
periods?
SOLUTION
74 8: National Insurance contributions Principles of Tax

INTERACTIVE QUESTION: CLASS 1 SECONDARY CONTRIBUTIONS

Meg is employed by Green Ltd and paid £424 weekly.

Munroe is also employed by Green Ltd and paid £4,800 monthly.
Requirement
Calculate the weekly and monthly secondary Class 1 contributions payable by Green Ltd in respect of
Meg and Munroe respectively. Ignore employment allowance for now.
SOLUTION

INTERACTIVE QUESTION: CLASS 1 SECONDARY CONTRIBUTIONS – YOUNG WORKERS

Oliver, aged 18, is employed by Blue Ltd and is paid £424 weekly.
Nora, aged 19, is also employed by Blue Ltd and is paid £4,800 monthly.
Kieran, aged 22, is employed by Blue Ltd as an apprentice and is paid £4,500 monthly.
Requirement
Calculate the weekly (for Oliver) and monthly (for Nora and Kieran) secondary Class 1 contributions
payable by Blue Ltd in respect of these employees. Ignore Blue Ltd's employment allowance for now.
SOLUTION
Principles of Tax 8: National Insurance contributions 75

2.2 Employment Allowance

Each employer can reduce their liability to NIC by £5,000 per annum. This can be used to reduce the
liability to nil. The allowance is per employer regardless of the number of employees.
The allowance is not available to:
 companies with a single director and no other employees, or
 businesses whose total Class 1 secondary NIC liability was £100,000 or over in the previous year.

EXAM SMART
In the exam you should include the employment allowance in calculations of Secondary
Class 1 NIC where applicable unless you are told otherwise.

INTERACTIVE QUESTION: EMPLOYMENT ALLOWANCE

Crimson Ltd employs three individuals, each on a salary of £60,000 per year.
Requirement
Calculate the Class 1 Secondary contributions payable by Crimson Ltd for 2022/23.
SOLUTION

3 Class 1A NICs
3.1 Class 1A contributions
Employers are also liable to pay Class 1A contributions on taxable benefits provided to employees at
the rate of 15.05%.
The value of the taxable benefits for NICs is generally the same as the taxable value for income tax.
However, any benefits taxed as earnings under Class 1 are not also subject to Class 1A charge.
76 8: National Insurance contributions Principles of Tax

INTERACTIVE QUESTION: CLASS 1A CONTRIBUTIONS

Beryl is employed by Z plc. During 2022/23, she received the following benefits:
£
Medical insurance 810
Car benefit 3,500
Vouchers exchangeable for goods 750
Pension advice (available to all employees) 100
Beryl is a higher rate taxpayer.
Requirement
Calculate the Class 1A contributions payable by Z plc.
SOLUTION

4 Class 2 NICs
4.1 Flat rate contributions
A self-employed individual aged between 16 and state pension age is required to pay flat rate weekly
Class 2 contributions (£3.15 per week for 2022/23).
Payments start on the individual’s 16th birthday and cease on reaching state pension age.

4.2 Lower profits limit

No Class 2 contributions are payable if the individual’s profits are below the lower profits limit
(£11,908 for 2022/23).
If profits are below the lower profits limit, but in excess of the small profits threshold (£6,725 for
2022/23), payment of Class 2 NIC is treated as having been made, thereby maintaining the taxpayer’s
contributions record for the purpose of contributory state benefits.

5 Class 4 NICs
5.1 Earnings related contributions
In addition to the flat rate Class 2 liability, self-employed individuals may also be liable to pay Class 4
NICs based on their taxable trading profit.
Principles of Tax 8: National Insurance contributions 77

An individual is liable to pay Class 4 contributions if aged 16 or over at the start of the tax year and
ceases to be liable if his state pension age birthday has been reached by the start of the tax year.
In a partnership, each partner is responsible for paying Class 2 and 4 contributions based on his own
share of the profits.

INTERACTIVE QUESTION: CLASS 2 AND 4 CONTRIBUTIONS

Andreas has been self-employed for many years. His accounts to 5 April 2023 showed a taxable profit
of £12,200.
Requirement
What are the Class 2 and Class 4 NICs payable by Andreas in 2022/23?
SOLUTION

5.2 Registering to pay Class 2 and Class 4 NICs

A newly self-employed individual must register as self-employed for income tax and national insurance
purposes in time for a return to be issued and submitted by 31 January following the tax year in which
self-employment commenced.
78 8: National Insurance contributions Principles of Tax

6 Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Do you know the different classes of NIC and to which income they apply?

Can you compute Class 1 Primary NIC for an employee for a specific earnings
period?

Do you understand the different thresholds used for Class 1 Secondary NIC, and
how to identify which threshold to use?

What is Class 1A NIC and who suffers it?

Can you calculate the total NIC liability of a sole trader or partner?
 79

Capital gains tax – individuals

Topic List
1. Chargeable and exempt persons, assets and disposals
2. Computing a gain or loss
3. Capital gains tax payable by individuals
4. Chattels
5. Knowledge diagnostic

Learning Objectives
 Classify persons, assets and disposals as either chargeable or exempt for capital gains purposes
 Calculate the chargeable gains and losses on the disposal of assets
 Calculate total taxable gains for both individuals and companies
 Calculate the capital gains tax payable by individuals
80 9: Capital gains tax – individuals Principles of Tax

1 Chargeable and exempt persons, assets and disposals

1.1 Introduction
A capital gain may arise on the disposal of a capital asset such as land, shares or a work of art. Usually,
if the asset has increased in value since it was acquired, there will be a chargeable gain on its disposal.
If the asset has fallen in value, there will be an allowable loss on its disposal.
Individuals pay capital gains tax (CGT) on their taxable gains. CGT applies to taxable gains in a tax year.
The first step in deciding whether there is a chargeable gain or allowable loss is to ascertain whether a:
(1) chargeable person has made a
(2) chargeable disposal of a
(3) chargeable asset.

1.2 Chargeable persons

Chargeable persons include:
 Individuals
 Business partners
 Trustees
 Companies, who pay corporation tax on their chargeable gains, not CGT
Some persons are specifically exempt from capital gains (e.g. charities and registered pension
schemes)

1.3 Chargeable disposals

Chargeable disposals include:
 The sale of the whole or part of an asset
 The gift of the whole or part of an asset
 The loss or destruction of the whole or part of an asset
 Appropriations to trading stock (deemed to take place at market value)
Exempt disposals include gifts to charities, art galleries, museums and similar institutions.
Death is not a disposal for capital gains tax purposes and so no CGT applies on death.
The date of disposal is the date when the contract (unconditional) for sale is made.

1.4 Chargeable and exempt assets

Chargeable assets are defined as all capital assets except those which are specifically exempt from
CGT.
Chargeable assets include both tangible assets (such as land, furniture, and works of art) and
intangible assets (such as the goodwill of a business, shares, and leases).
Exempt assets include:
 Legal tender (i.e. cash)
 Motor cars (including vintage and classic cars)
 Most wasting chattels
 Chattels which are not wasting chattels if acquisition cost and gross disposal consideration does
not exceed £6,000
 Gilt-edged securities (such as Exchequer Stock or Treasury Stock)
Principles of Tax 9: Capital gains tax – individuals 81

 National Savings Certificates and premium bonds

 Shares and investments held in an Individual Savings Account (ISA)

2 Computing a gain or loss

£
Disposal proceeds (consideration) X
Less: incidental costs of disposal (X)
Net disposal proceeds X
Less: Allowable costs (X)
Chargeable gains/ allowable loss X

EXAM SMART
This proforma is more important for future tax papers than for the objective test questions
at this level, however it is important you get into the habit of using this proforma and
understand that a separate calculation is performed using the above format for each
chargeable disposal in the tax year.

2.1 Disposal consideration

If the asset is sold in a commercial transaction, i.e. sold at arm's length, the disposal consideration is
the gross sale proceeds.
If the asset is not sold at arm's length, for example the asset is gifted, the disposal consideration is the
market value of the asset.
From the disposal value, incidental costs of disposal can be deducted to give the net disposal
consideration (e.g. incidental costs of disposal include legal fees, estate agents' and auctioneers' fees
and advertising costs).

2.2 Allowable costs for CGT purposes

In order to calculate a gain or loss, you need to deduct allowable costs from net disposal consideration.
Allowable costs are:
 Acquisition cost of the asset: purchase price if bought, market value of asset if gifted, probate
value if acquired on death
 Incidental costs of acquisition such as legal fees, surveyor’s or valuer’s fees, stamp duty land tax,
stamp duty
 Enhancement expenditure: capital costs of additions and improvements to the asset reflected in
the value of the asset at the date of disposal, such as extensions, planning permission and
architects’ fees for extensions
82 9: Capital gains tax – individuals Principles of Tax

INTERACTIVE QUESTION: ALLOWABLE COSTS

Paul bought a holiday cottage which cost £120,000 and he paid surveyor's fees of £1,500 and legal fees
of £1,000 in connection with the acquisition.
The following year, Paul spent the following on improvements to the cottage:
 £2,000 installing central heating
 £500 on repairs to the roof
 £1,200 redecoration
 £5,000 on a sun room extension
Four years later, during a storm, the sun room was destroyed and not replaced.
Paul later sold the cottage at auction. The gross sale proceeds were £180,000. Auctioneers' fees were
£4,500 and he also paid legal fees of £1,200 on the sale.
Requirement
What is Paul's chargeable gain on sale?
SOLUTION

3 Capital gains tax payable by individuals

3.1 Annual exempt amount
Each individual is entitled to an annual exempt amount each tax year. For 2022/23 the annual exempt
amount is £12,300.
The annual exempt amount is deducted from chargeable gains to produce gains liable to CGT, called
taxable gains.
If the annual exempt amount is unused in a year it is wasted and cannot be used in any other tax year.
Principles of Tax 9: Capital gains tax – individuals 83

3.2 Computing capital gains tax

Individuals are taxed on their taxable gains separately from their taxable income but the rate of tax is
calculated as if the gains were the top slice of the taxpayer’s income.
 Capital gains falling within the basic rate tax band are taxed at 10%.
 Capital gains falling within the higher or additional rate tax band are taxed at 20%.

EXAM SMART
There are different rates of CGT for gains on residential property, but these are not in the
syllabus for this examination. Therefore, in questions asking you to calculate CGT, you should
assume the gains have not arisen from the sale of residential property.

INTERACTIVE QUESTION: CGT LIABILITY

Olly has taxable income in 2022/23 of £29,200. He makes taxable gains of £21,500 in the year. Olly’s
sister Alice has taxable income of £8,000 in 2022/23. She makes taxable gains of £17,000 in the year.
Requirement
What are Olly's and Alice’s CGT liabilities for 2022/23?
SOLUTION

EXAM SMART
To work out the CGT liability it is important to methodically work through several processes
in the correct order:
 Determine the chargeable assets
 Compute the gains or losses on those assets to find total gains for the tax year
 Deduct the AEA from the total gains to arrive at the taxable gains
 Determine the correct amount of tax by checking the individual’s taxable income and
checking for any remaining basic rate band.
84 9: Capital gains tax – individuals Principles of Tax

4 Chattels
4.1 What are chattels?
A chattel is an item of tangible moveable property.
A chattel is a wasting chattel if it has a predictable life at the date of disposal not exceeding 50 years.
Examples include caravans, boats, computers, mechanical items (including watches and clocks), and
animals. Plant and machinery are always treated as having a useful life of less than 50 years.
A non-wasting chattel is one with a predictable life at the date of disposal of more than 50 years.
Examples include antiques, jewellery and works of art.

4.2 Wasting chattels

Wasting chattels are usually exempt from CGT so there will be no chargeable gain or allowable loss on
disposal.
However, if the asset has been used solely in a business and the owner has, or could have, claimed
capital allowances on the asset, it will be treated as a non-wasting chattel.

4.3 Non-wasting chattels

Non-wasting chattels are generally chargeable to CGT, subject to some special rules.
 If the asset is disposed of for gross disposal proceeds of £6,000 or less and acquired for £6,000
or less, it is exempt.
 If the asset is disposed of for gross disposal proceeds of more than £6,000 and the acquisition
cost is £6,000 or less, there is marginal relief for the gain. The gain cannot exceed:
5/3 × (Gross proceeds less £6,000)
 If the chattel is sold for less than £6,000 and the disposal would result in a loss, the loss is
restricted by assuming that the gross disposal proceeds were £6,000.

Summary of the taxation of non-wasting chattels

Purchase price Sale proceeds Tax treatment
≤£6,000 ≤£6,000 Exempt
≤£6,000 >£6,000 5/3 (SP – £6,000)
>£6,000 <£6,000 Restrict loss (deemed proceeds £6,000)
>£6,000 >£6,000 Normal CGT
Principles of Tax 9: Capital gains tax – individuals 85

INTERACTIVE QUESTION: CHATTELS – GAIN

Martin bought a vase for £4,000. He sold it the following year at auction for £7,000. The costs of sale
amounted to £350.
Requirement
What is Martin's chargeable gain on sale?
SOLUTION

INTERACTIVE QUESTION: CHATTELS – LOSS

Lucinda bought an antique necklace several years ago for £8,000 and sold it recently at auction for
£5,400. The costs of sale were £270.
Requirement
What is Lucinda's allowable loss?
SOLUTION

4.4 Set of non-wasting chattels

Chattels form a ‘set’ when similar or complementary items are worth more together than separately,
for example a pair of paintings by the same artist.
Part disposal from a set of chattels
If an asset from a ‘set’ is disposed of a proportion of the cost for the set needs to be allocated to the
part being disposed of.
 The formula A/ A+B is used
 A = value of part disposed (gross proceeds)
 B = current market value of part retained
86 9: Capital gains tax – individuals Principles of Tax

The £6,000 chattels threshold is then compared to the proceeds and the apportioned part of the cost.
The remaining cost is used for future disposals of the rest of the set.

INTERACTIVE QUESTION: PART DISPOSAL FROM A SET OF CHATTELS

Alex sells a chair at auction for gross proceeds of £14,000. Auctioneer’s fees of 10% are payable. The
chair was from a dining set he bought many years ago for £45,000, and the remaining chairs and table
were estimated to be worth £60,000 at the date of disposal.
Requirement
Calculate the chargeable gain or allowable loss arising on the disposal of the chair.
SOLUTION

Disposals to connected persons

There are special rules where two or more assets forming part of a set of chattels owned by the same
person are disposed of to:
 the same person;
 persons acting in concert; or
 persons connected with each other (ie. relatives including in-laws, and business partners).
The disposals are computed separately using the part disposal rules above but treated as one disposal
for the £6,000 exemption and marginal relief. Loss rules apply in similar way.
If the disposals are in different tax years an apportionment of the total gain (loss) will be required
made of the basis of disposal proceeds.

EXAM SMART
Questions in the exam will state (where relevant) whether two parties are connected.
Principles of Tax 9: Capital gains tax – individuals 87

INTERACTIVE QUESTION: PART DISPOSALS TO CONNECTED PERSONS

Sue owned a set of two paintings which cost £2,000 in July 2002.
In May 2022 she sold one of the paintings to Lloyd for £5,500. The other painting was valued at £4,500
at this time.
In December 2022 she sold the other painting to Lloyd’s brother Lewis for £4,800. Lloyd and Lewis are
connected persons for CGT purposes.
Requirement
Show the chargeable gains on disposal.
SOLUTION
88 9: Capital gains tax – individuals Principles of Tax

5 Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you identify a chargeable person, a chargeable asset, and a chargeable

disposal?

Can you determine the correct disposal consideration and allowable costs in
computing a chargeable gain?

Do you understand how the CGT rate for individuals is determined?

Can you identify an item as a chattel, or a group of items as a set of chattels?

Do you know the “five-thirds” rule and when to apply it?

 89

10

Corporation tax

Topic List
1. Charge to corporation tax
2. Taxable total profits
3. Computation and payment of corporation tax
4. Knowledge diagnostic

Learning Objectives
 Calculate the chargeable gains and losses on the disposal of assets
 Calculate total taxable gains for companies
 Identify accounting periods for a company
 Recognise the interaction of having one or more related 51% group companies with corporation
tax payment dates
 Allocate given items of business expenditure as allowable or disallowable for tax purposes and
calculate the adjusted trading profits after capital allowances on plant and machinery
 Calculate the taxable total profits and the corporation tax payable for a company resident in the
UK which has a period of account of 12 months or less
90 10: Corporation tax Principles of Tax

1 Charge to corporation tax

1.1 Who is chargeable to corporation tax?
Corporation tax is charged on the income and gains of a company. These are known as taxable total
profits.

1.2 Residence
A company is liable to corporation tax on its worldwide profits if it is resident in the United Kingdom.
A company is resident in the UK if either:
 It is incorporated in the UK; or
 It is incorporated outside the UK, but its central management and control are exercised in the
UK.

1.3 Accounting periods

A company is charged to corporation tax in respect of an accounting period.
The accounting period will usually be the same as the company's period of account (the period for
which the company prepares its accounts).
An accounting period starts:
 When the company begins to trade or acquires a source of chargeable income
 When the previous accounting period ends and the company is still within the charge to
corporation tax
An accounting period ends on the earliest of:
 The end of 12 months from the start of the accounting period; or
 The date the company begins or ceases to trade; or
 The period of account ends.
If a company has a period of account exceeding 12 months, there will be two accounting periods, each
giving rise to a separate corporation tax computation. The first accounting period will be the first 12
months of the period. The second chargeable accounting period will be the remainder of the period of
account.

WORKED EXAMPLE: LONG PERIOD OF ACCOUNT

M Ltd has made up accounts to 31 December each year. For commercial reasons, it decides to prepare
its next set of accounts for the period 1 January 2022 to 30 April 2023.
Requirement
What are the accounting periods for this long period of account?
SOLUTION
First accounting period – 1 January 2022 – 31 December 2022
Second accounting period 1 January 2023 – 30 April 2023
Principles of Tax 10: Corporation tax 91

2 Taxable total profits

2.1 Overview of corporation tax computation
Per accounting period: £
Trading income X
Property income X
Non trading loan relationships (non-trading interest) X
Miscellaneous income – income not otherwise charged X
Chargeable gains X
Qualifying donations (X)
Taxable total profits X

EXAM SMART
In the scenario based corporation tax question you will need to populate the corporation tax
computation proforma that is provided for you. This proforma together with the information
below on how to compile each category will be vital to your future studies.

2.2 Trading income

A company's trading profits are calculated in a similar way to the taxable trading profits of a sole
trader or partnership.
The company will produce accounts for a period of account, and these must be adjusted for tax
purposes. Capital allowances are then deducted to produce a figure for trading income.

2.2.1 Adjustment to trading profits for companies

In general, the adjustment to profits calculation will follow the same rules as for a sole trader or
partnership, including WDAs, the AIA and FYAs, but there are some differences.
 As a company is a legal entity separate from its shareholders and directors, there is no
adjustment to profits needed for private expenses met by the company.
 For the same reason, there will be no adjustment for appropriation of profits (e.g. salary paid to
a director).
 Interest paid by a company in respect of a trading loan relationship will be an allowable expense
in the calculation of its trading income (see below)
 Dividends paid by a company are not allowable as a trading expense in the calculation of its
trading income.
 If the company has a long period of account, the tax-adjusted profits should be time
apportioned into the relevant chargeable accounting periods at this stage.

2.2.2 Capital allowances for companies

In general capital allowances seen earlier also apply to companies, however there are some important
differences:
 Capital allowances for companies are computed for accounting periods, not periods of account.
This means that capital allowances for companies can never be computed for a period longer
than 12 months and in a long period of account two separate capital allowances computations
are required.
92 10: Corporation tax Principles of Tax

 Capital allowance computations for companies will never include private use adjustments.
 A 100% FYA is available for expenditure incurred by a company on new (not second-hand) plant
and machinery for use in a designated enterprise zone. The expenditure must be incurred in the
eight years from the date the enterprise zone is established.
 From 1 April 2021, companies can claim a super-deduction at 130% for purchases of plant and
machinery in the main pool providing:
– the asset is new (not second hand),
– and is not a car.

EXAM SMART
 The special rules for the disposal of assets that have claimed the super-deduction are
not examinable in the exam.
 In the exam it should be assumed that a company will claim maximum possible capital
allowances when purchasing assets.

INTERACTIVE QUESTION: CAPITAL ALLOWANCES SUPER-DEDUCTION

F Ltd prepares accounts to March each year. As at 1 April 2022 the tax written down value of the main
pool was £250,000 and the following transactions took place during the 12 months to 31 March 2023.
15 May 2022 – Purchase of new machinery for £150,000
25 June 2022 – Purchase of Honda car for the finance director with CO2 emissions of 42g/km for
£32,000 (private use estimated to be 30%)
31 December 2022 – Disposal of office equipment for proceeds of £22,000
Requirement
Calculate the maximum capital allowances available to F Ltd for year ended 31 March 2023.
SOLUTION
Principles of Tax 10: Corporation tax 93

INTERACTIVE QUESTION: CAPITAL ALLOWANCES AND LONG PERIOD OF ACCOUNT

D Ltd makes up accounts for the 15-month period to 30 June.

Its tax-adjusted profits for the period were £300,000.
The tax written down value of the main pool at the beginning of the 15-month period was £24,000.
D Ltd sold some plant in the final month of the 15-month period for £3,000 (less than cost).
Requirement
What is the trading income for each chargeable accounting period?
SOLUTION

2.3 Property income

A company's rental income from property situated in the UK is taxed as property income. Rent
received is dealt with on an accruals basis. This means that only rent relating to the chargeable
accounting period is taken into account. The date of receipt is not relevant.
94 10: Corporation tax Principles of Tax

INTERACTIVE QUESTION: PROPERTY INCOME

H Ltd makes up its accounts to 31 July each year.

On 1 January, H Ltd bought and immediately rented out a shop. The annual rental of £24,000 was
payable on that date.
Requirement
What is the amount taxable as property income on H Ltd for the year ended 31 July?
SOLUTION

Interest payable on a loan taken out by a company for the purpose of buying or improving let property
is not an allowable expense for property income. Instead it is dealt with under the loan relationship
rules (see later in this section). No further knowledge of the property income calculation is required at
certificate level.

2.4 Dividends received

A company rarely pays tax on dividends received from other companies. They are therefore ignored in
computing taxable total profits. For the purposes of the exam, assume all dividends received by a
company are exempt.
However, dividends received from other companies are taken into account in determining when a
company has to pay its corporation tax liability. This is dealt with in the next section of this chapter.

2.5 Loan relationships – interest

Interest payable and receivable, such as investment interest is allowable and taxable respectively as a
loss or profit on non-trading loan relationships (see later in this section).
This income is received gross.

2.6 Chargeable gains

Chargeable gains are included in the computation of taxable total profits (TTP).
Principles of Tax 10: Corporation tax 95

Overview of computation of a chargeable gain for a company

£
Disposal consideration X
Less: Incidental costs of disposal (X)
Net disposal consideration X
Less: Allowable costs (X)
Chargeable gain X

Gains are initially computed in the same way as for individuals (see earlier in these notes), however,
for companies, no annual exempt amount is available.
In practice if an asset was acquired before 1 January 2018 a relief for inflation known as ‘indexation
allowance’ is available in arriving at the chargeable gain.

EXAM SMART
Indexation allowance is not examinable in the Principles of Taxation exam and all questions
involving disposals by companies will therefore have been incurred on or after 1 January
2018.

INTERACTIVE QUESTION: CHARGEABLE GAIN FOR A COMPANY

Luggnag Ltd bought an asset on 3 March 2019 for £100,000. In addition, there were legal expenses of
£5,000 on the purchase.
The company sold the asset on 15 September 2022 for £140,000 and paid legal costs of £6,000 on sale.
Requirement
What is Luggnag Ltd’s chargeable gain on sale?
SOLUTION

Companies are not entitled to an annual exempt amount.

Exempt items are the same as for individuals except goodwill created or acquired on or after 1 April
2002 is exempt.
96 10: Corporation tax Principles of Tax

2.7 Miscellaneous income – income not otherwise charged

Miscellaneous income received by a company is taxable as income not otherwise charged. Such
income is received gross.

2.8 Qualifying donations

A company makes qualifying donations gross. The amount paid in the chargeable accounting period is
deducted from the company's total income and gains. This is called a qualifying charitable donation
(QCD).

2.9 Loan relationships

A company has a loan relationship if it loans money as a creditor or is loaned money as a debtor. The
tax treatment will depend upon whether or not the loan was entered into for trading purposes. This is
summarised on the tables below.

2.10 Trading loan relationships

Gross interest payable Gross interest receivable
Treatment for corporation Allowable trading expense to set Trading receipt treated as trading
tax against trading income income
Basis of assessment Accruals basis Accruals basis
Main examples Bank overdraft interest Rare – a company will not usually lend
Interest on loans to buy plant and money for trade purposes
machinery
Interest on loans to buy premises for
use in the trade

If the company has been lent money or lends money for a non-trade purpose, there is a non-trading
loan relationship.

2.11 Non-trading loan relationships

Gross interest payable Gross interest receivable
Treatment for corporation Non-trading loan relationship 'debit' Non-trading loan relationship 'credit'
tax
Basis of assessment Accruals basis Accruals basis
Main examples Interest on loans to: Interest on
 purchase/improve a let property  bank and building society
 acquire shares in another accounts
company  gilt-edged securities
 interest on overdue corporation  debentures and other loan stock
tax  repayments of overpaid
 write off of a non-trading loan corporation tax (repayment
such as a loan to a former supplement)
employee
Principles of Tax 10: Corporation tax 97

EXAM SMART

The credits (income) and debits (expenses) on loan relationships are combined. If there is a net profit,
this amount is taxable as a non-trading loan relationship.
Not examinable – If there is a net deficit, there will be no amount taxable under loan
relationships. The deficit can be relieved in a number of ways. These are beyond the
syllabus of this exam.

INTERACTIVE QUESTION: NON-TRADING LOAN RELATIONSHIPS

K Ltd had the following accrued income received and interest paid:
Building society interest receivable £5,000
Bank interest receivable £2,000
Repayment interest on overpaid corporation tax £50
Payable on loan taken out to acquire let property £3,250
Payable on loan to acquire plant and machinery £650
Requirement
What is the amount taxable as a non-trading loan relationship?
SOLUTION

2.12 Taxable total profits

A company's total income and gains less charges on income is its taxable total profits.

WORKED EXAMPLE: TAXABLE TOTAL PROFITS

X Ltd has the following results:

Tax-adjusted trading profits before capital allowances £120,000
Capital allowances £10,000
Rental income after expenses £5,000
Interest received from bank £1,000
Chargeable gain £2,000
Qualifying donation paid £3,000
Requirement
What are the taxable total profits of X Ltd?
98 10: Corporation tax Principles of Tax

SOLUTION
Tax-adjusted trading profits before capital allowances 120,000
Less: capital allowances (10,000)
Trading income 110,000
Property income 5,000
Non-trading loan relationship 1,000
Chargeable gains 2,000
118,000
Less: Qualifying charitable donations (3,000)
Taxable total profits (TTP) 115,000

3 Computation and payment of corporation tax

3.1 Rate of corporation tax
A company's corporation tax liability is computed by applying the corporation tax rate to the
company's taxable total profits.
Rates of corporation tax are fixed for Financial Years (FYs). A financial year (FY) runs from 1 April to
the following 31 March. At present, all companies pay corporation tax at the same rate.

EXAM SMART
 FY 2022 runs from 1 April 2022 to 31 March 2023. The rate for FY 2022 is 19%.
 In the past there have been varying rates of corporation tax for companies with
different levels of profit (and varying rates are to be re-introduced from 1 April 2023),
but these are not examinable

INTERACTIVE QUESTION: CORPORATION TAX

T Ltd makes up its accounts to 31 March each year. In the year to 31 March 2023, the company has
TTP of £1,300,000.
Requirement
What is the corporation tax liability of T Ltd?
SOLUTION
Principles of Tax 10: Corporation tax 99

3.2 Payment of corporation tax

3.2.1 'Augmented profits'
In the last section, we looked at the computation of TTP (taxable total profits) and used this to
calculate the corporation tax liability of a company.
You also need to work out the 'augmented profits' of a company as this will govern when a company
pays tax.

KEY TERMS
'Augmented profits': Taxable total profits plus exempt ABGH distributions.
Exempt ABGH distributions - Include dividends received from UK and overseas companies
other than those within 51% group

INTERACTIVE QUESTION: AUGMENTED PROFITS

Z Ltd has taxable total profits of £500,000 and receives exempt dividends from an unrelated UK
company of £10,000, and exempt dividends of £7,000 from its wholly owned subsidiary.
Requirement
What are the augmented profits of Z Ltd?
SOLUTION

Augmented profits are compared with the limits of £1.5 million and £20 million to decide when
corporation tax is payable. The limits are adjusted down for periods of less than 12 months and also
by the number of related 51% group companies at the end of the previous accounting period.

KEY TERMS: RELATED 51% GROUP COMPANIES

Company B is a related 51% group company of another company A in an accounting period if
for any part of the accounting period, A is a 51% subsidiary of B, or B is a 51% subsidiary of
A, or both A and B are 51% subsidiaries of the same company

 Ignore dormant companies for these purposes

 Divide the limits used for determining a company’s corporation tax payment date(s) by the
number of related 51% group companies

3.2.2 Payment – Non large companies

The due date for corporation tax payable by companies not treated as large or very large (see below) is
nine months and one day after the end of the chargeable accounting period.
100 10: Corporation tax Principles of Tax

3.2.3 Payment – Large companies

A large company is one which has augmented profits in excess of the £1,500,000, but not exceeding
£20 million.
However, a company is not treated as large if:
 It has a tax liability of less than £10,000; or
 It was not a large company in the preceding 12 months, and it has augmented profits of
£10 million or less in this chargeable accounting period. (The £10 million limit is divided
between 51% group associates.)
A large company is required to pay corporation tax in four equal instalments based on the company's
estimated liability for the accounting period.
The instalments are due on the 14th day of the 7th, 10th, 13th and 16th months after the start of a
12-month accounting period.

3.2.4 Payment – Very large companies

Companies with augmented profits exceeding £20 million in accounting periods starting on or after
1 April 2019 will continue to pay quarterly instalments but four months earlier than large companies.
Instalments are therefore due on 14th day of months 3, 6, 9 and 12 of the accounting period.

INTERACTIVE QUESTION: IMPACT OF RELATED 51% GROUP COMPANIES ON £1,500,000 LIMIT

X plc owns 80% of Y Ltd and Y owns 80% of Z Ltd and has done for a number of years.
Requirement
What are the limits to be used when determining payment date(s) for X Plc’s corporation tax?
SOLUTION
Principles of Tax 10: Corporation tax 101

INTERACTIVE QUESTION: PAYMENT BY INSTALMENTS

V Ltd has augmented profits of £26.3 million in the year ended 31 March 2023.
Requirement
When will V Ltd be required to pay instalments of corporation tax for the year ended 31 March 2023.
SOLUTION

EXAM SMART
You will not be asked to calculate the payment dates for a large or very large company with
a short accounting period, but you may be asked to calculate the augmented profits limit for
such a company with a short accounting period.

4 Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you correctly split a long period of account into separate chargeable
accounting periods?

Do you understand the different elements of the corporation tax proforma?

Do you know how to calculate a chargeable gain?

Can you distinguish between a trading and a non-trading loan relationship?

Do you understand the definition and relevance of related 51% group companies?
102 10: Corporation tax Principles of Tax
 103

11

Value Added Tax

Topic List
1. The principles of value added tax (VAT)
2. Classification of supplies
3. Registration and deregistration
4. Output VAT
5. Input VAT
6. Knowledge diagnostic

Learning Objectives
 Classify supplies in given straightforward situations as exempt, zero rated, standard rated,
subject to a reduced rate of 5% or outside the scope of VAT
 Recognise the implications of supplies being classified as reduced-rated, standard rated, zero
rated or exempt
 Identify when a business could or should register or deregister for VAT and state the time limits
 Determine the tax point for a supply of goods or services
 State the principles of VAT payable or repayable on the supply of goods or services by a taxable
person
104 11: Value Added Tax Principles of Tax

1 The principles of value added tax (VAT)

1.1 How VAT works
Value added tax (VAT) is a tax payable on the consumption of goods and services by the final
consumer.
However, instead of all the tax being collected at the final point of consumption, VAT is collected as
value is added to the goods or services.
Output VAT: As the goods or services go through the production and distribution process, each VAT
registered business charges VAT on the value of the goods or services it supplies. This is called output
VAT.
Input VAT: Each VAT registered business receives credit for any VAT that it has paid. This is called input
VAT.
The business sets off input VAT against output VAT. Usually this results in a net excess of output VAT
which the business pays over to HMRC.
The total tax is ultimately borne by the final consumer of the goods or services at the end of the
distribution chain.

WORKED EXAMPLE: OPERATION OF VAT

Gerald makes car components which attract VAT of 20%. He sells them to William, a car component
wholesaler, for £80 plus VAT of £16 (20% of £80).
William holds the car components in stock until he sells them to Fiona, who runs a car dealership, for
£120 plus VAT of £24 (20% of £120).
Fiona sells the components to Richard, a private customer, for £160 plus VAT of £32 (20% of £160).
Requirement
How does VAT operate in this distribution chain?
SOLUTION
Gerald William Fiona Total
Output tax £16 £24 £32 –
Less: input tax (nil) (£16) (£24) –
Net excess £16 £8 £8 £32

Richard is unable to reclaim any VAT as he is a private customer and not VAT registered and therefore
suffers the total VAT charge of £32. Gerald, William, and Fiona merely collect and pay the VAT to
HMRC without actually suffering any VAT.

1.2 Scope of VAT

VAT is charged on the taxable supply of goods and services in the United Kingdom by a taxable person
in the course of a business carried on by him.
Principles of Tax 11: Value Added Tax 105

KEY TERMS
Taxable supply: any supply of goods or services made in the UK other than an exempt supply
or a supply outside the scope of VAT.
Taxable person: a person making taxable supplies who is, or who is required to be,
registered for VAT. Person includes a sole trader, a partnership and a company.

2 Classification of supplies
Supplies of goods or services

Taxable Supplies Exempt supplies Outside the scope

A supply on which output tax A supply upon which NO No VAT
is charged and input tax is output tax is charged, and consequences
recoverable input tax is not recoverable
eg – wages and
eg
dividends
• land
• insurance
• postal services

Standard rated Reduced rate Zero rated (0%)

(20%) eg
eg
• basic food
Any taxable
• domestic fuel • animal food
supply which is
not zero or • children’s car • books/ newspapers/
reduced rated seats e-publications
• children’s clothes

2.1 Supplies of goods and services

Examples of supplies of goods include:
 Sales of goods for consideration
 Gifts of business assets except where total gifts made to the same person do not exceed £50 in
any 12-month period or the gift is a sample (but if two or more identical samples are given to
the same person, only one is deemed not to be a supply)
 Goods permanently taken out of a business for private use by the owner or an employee
 Sales of goods on hire purchase
A supply of services is any supply for a consideration which is not a supply of goods. Consideration is
any form of payment in money or in kind. Therefore, a gift of services is not a taxable supply.
106 11: Value Added Tax Principles of Tax

Examples of supplies of services include:

 Sales of services for consideration
 Hiring of goods to a customer
 Goods owned by a business temporarily taken for private use by the owner or an employee
 Private use, by the owner or an employee, of business services supplied to the business
 Private use of fuel for motoring by the owner or an employee (but not the private use of a
business motor car itself)

3 Registration and deregistration

3.1 Compulsory registration
Where the total value of taxable supplies (taxable turnover) exceeds the statutory threshold
(£85,000). Taxable supplies include zero rated, reduced rated and standard rated supplies. It does not
include supplies of capital assets of the business.
A person's registration covers all of his business activities as it is the person who is registered, not his
business. Registration / deregistration is made online.
The statutory threshold is £85,000.
There are two situations where compulsory registration is required.

3.1.1 Historic test

 At the end of any month, the taxable turnover for the previous twelve months exceeds the
threshold.
 Notify HMRC within thirty days of the end of the month in which the threshold was exceeded
(the relevant month).
 Registration then takes effect from the first day after the end of the month following the
relevant month.
 Registration is not required if the taxable turnover during the next twelve months will not
exceed the deregistration threshold (see later in this section).

INTERACTIVE QUESTION: HISTORIC TEST FOR REGISTRATION

Caroline started trading on 1 July 2022. Her monthly turnover (excluding VAT) is:
£
Standard rated supplies 7,560
Zero rated supplies 950
Exempt supplies 500
9,010

On 1 February 2023, Caroline sold a machine used in her business for £2,500 (excluding VAT).
Requirement
On what date is the VAT registration threshold first exceeded by Caroline, by what date will she need
to notify HMRC and what is the date from which she will be registered?
Principles of Tax 11: Value Added Tax 107

SOLUTION

3.1.2 The future prospects test.

 The person must register for VAT if, at any time, there are reasonable grounds for believing that
the taxable turnover in the next 30 days alone will exceed the threshold.
 If a person is liable to register under the future prospects test, he must notify HMRC by the end
of the 30-day period in which the threshold is expected to be exceeded.
 Registration takes effect from the beginning of the 30-day period.
If a taxpayer fails to notify HMRC of the liability to register on time, a penalty will be payable.

3.2 Voluntary registration

 A person making taxable supplies below the registration threshold may apply for voluntary
registration.
 HMRC will register that person for VAT from a mutually agreed date.
 The main advantage of voluntary registration is the ability to recover input VAT.

3.3 Exemption from registration

 On request where a person is making only zero-rated supplies
 On request if only a small proportion of supplies are standard rated and the person would
normally have a net recovery of input VAT.

3.4 Deregistration
 Deregistration is compulsory if a person ceases to make taxable supplies and has no intention of
making taxable supplies.
 The person must notify HMRC within 30 days.
 Deregistration will take effect on the date taxable supplies ceased.
 A person is eligible for voluntary deregistration if his estimated taxable turnover for the next
twelve months will not exceed the statutory deregistration threshold (£2,000 below the
registration threshold).
 Voluntary deregistration takes effect from the date on which the request is made or from an
agreed later date.
 VAT deregistration can be completed online.
 On deregistration, a VAT charge is made on a deemed supply of trading stock and capital assets
on which input VAT has been recovered. Output tax is then paid on the deemed supply. If the
amount of output VAT is £1,000 or less, it does not have to be paid.
108 11: Value Added Tax Principles of Tax

4 Output VAT
4.1 Charge to VAT
VAT charged on taxable supplies is based on the VAT exclusive value of the supply. For standard rated
items, the rate of VAT is 20%. For the purposes of your exam use a standard rate of VAT of 20%
throughout.
If the VAT inclusive price is given, the VAT component of the consideration is:
20 or 1
This is called the VAT fraction.
120 6

INTERACTIVE QUESTION: CHARGE TO VAT – STANDARD RATED SUPPLIES

J Ltd makes standard rated supplies. It makes the following standard rated supplies:
VAT-exclusive supplies £395
VAT-inclusive supplies £3,450
Requirement
What is the VAT charged?
SOLUTION

For reduced-rate supplies VAT is charged at 5% on the VAT exclusive value of the supply.
If the VAT-inclusive price is given for reduced-rate supplies, the VAT component of the consideration is
5 or 1
105 21

EXAM SMART
When the calculation of VAT amounts is needed, it is vital to determine whether the figures
given are VAT exclusive (net) or VAT inclusive (gross)
Principles of Tax 11: Value Added Tax 109

INTERACTIVE QUESTION: CHARGE TO VAT – REDUCED-RATE SUPPLIES

H Ltd makes reduced-rate supplies. It makes the following supplies:

VAT-exclusive supplies £500
VAT-inclusive supplies £1,260
Requirement
What is the VAT charged?
SOLUTION

4.2 Time of supply (tax point)

VAT becomes due on a supply of goods or services at the time of supply. This is called the tax point.
Normally VAT must be accounted for on the VAT return for the period in which the tax point occurs.
The basic tax point is the date on which goods are removed or made available to the customer or the
date on which services are completed. However, in certain circumstances the actual tax point (the
date of invoice or payment) may override the basic tax point.
The time of supply can therefore be said to be the earlier of
 The date the goods are supplied. (Although, if the invoice is issued within 14 days after basic
tax point, the actual tax point is the date of invoice.)
 The date payment is received. If a deposit is paid, there will be separate tax points for the
deposit and the balancing payment.
 The date the invoice is issued.
Goods supplied on a sale or return basis (i.e. if the customer does not sell the goods, they may be
returned to the supplier) are treated as having a basic tax point which is the earlier of the adoption of
the goods by the customer or twelve months after the date of dispatch.

4.3 Value of supply

Usually the value of the supply is the amount charged by the supplier, exclusive of any VAT.
Where the supply is a gift of business assets, the value of the supply is the VAT exclusive amount that
would be payable by the person making the supply at that time to purchase goods identical to the
goods concerned (i.e. replacement cost).
Non-business use of business assets is valued at the full cost to the taxable person of provision.
110 11: Value Added Tax Principles of Tax

4.3.1 Discounted supplies

Supplies offered at a discount. If this is a trade discount the goods are valued net of the discount. If
the discount is an early payment (settlement) discount the trader has 2 choices:
 The supplier can charge the full amount on the invoice and then later issue a credit note if the
discount is taken up, or
 The invoice must contain the terms of the discount and a statement that the trader can only
recover the input tax actually paid by the supplier. The invoice must show the discounted price,
VAT on this and the total amount due if the discount is taken up. The trader can then only
recover input VAT if he has evidence of the payment actually made e.g. a bank statement.

INTERACTIVE QUESTION: SALE WITH DISCOUNT

B Ltd makes a standard rated taxable supply of goods. It issues an invoice for £1,000 (exclusive of VAT)
to V Ltd on 30 June.
A 3% discount is offered for payment within 30 days of the invoice date.
Requirement
What is the value of the supply and how much output VAT is charged, assuming that V Ltd pays the
invoice within 30 days?
SOLUTION

4.3.2 Fuel
Fuel provided for private motoring by the owner or an employee is charged at a scale rate. The fuel
scale charge is based solely on the CO2 rating of a car and represents the VAT inclusive deemed value
of the fuel supplied. There are no adjustments for fuel type. Fuel scale charges will be provided in the
exam when fuel for private motoring is tested.
Principles of Tax 11: Value Added Tax 111

INTERACTIVE QUESTION: FUEL SCALE CHARGE

Jethro is employed by A Ltd. He is provided with a car with CO2 emissions of 175g/km and petrol for
business and private use.
The VAT-inclusive quarterly scale rate for a car with CO2 emissions between 175g/km and 179g/km is
£437.
Requirement
What is the output VAT due for the quarter to 31 March?
SOLUTION

4.4 Bad debts

Output VAT is accounted for according to the tax point and therefore output VAT may be payable
before payment of an invoice has been received from the customer.
Bad debt relief is available if:
 the invoice is more than six months overdue
 the debt has been written off in the supplier's accounts
 the claim is made within four years of the time the debt became eligible for relief
 the supplier has a copy of the VAT invoice and records to show that the output VAT has
been paid.
The VAT is reclaimed in the supplier's VAT return together with input tax on purchases.

5 Input VAT
5.1 Recoverable VAT
Normally, a taxable person making wholly taxable supplies (zero rated, reduced rate or standard rated)
can recover input VAT on purchases and expenses relating to the taxable supply of goods.
Input VAT may be recovered if:
 The goods or services have been supplied
 The input VAT recoverable is supported by a VAT invoice
 The goods or services are used for a business purpose
112 11: Value Added Tax Principles of Tax

 Where goods are bought partly for business use, the taxable person may either:
– deduct all the input tax and account for the output tax in respect of private use; or
– deduct only the business proportion of input tax.
 Where services are bought partly for private use, only the second method can be used
 Input VAT is also recoverable on fuel supplied for private use where the VAT scale charge for
output tax applies.
Input tax on assets purchased for the use of employees (as opposed to directors or sole traders or
partners) which have an element of private use is allowable in full. Such benefits are a legitimate
business expense and are provided for the purposes of the business – mainly to reward or motivate
staff. The VAT incurred on their provision is consequently all input tax and no apportionment is
necessary to reflect the private use. Examples include the cost of purchasing a mobile telephone (but
not the cost of usage), or a computer but not cars which have special rules regarding private usage.

5.2 Irrecoverable VAT

Input VAT is not usually recoverable in respect of:
 Motor cars (including optional extras acquired with the car) unless the car is used exclusively for
business purposes
 Goods or services used for the purposes of business entertaining which is not allowable when
computing taxable trading profits. VAT in respect of staff entertainment and foreign business
customers is allowable.
 Items where no VAT receipt is held
 Non-business items

5.3 Pre-registration VAT

Input VAT can be recovered on goods and services supplied before registration as follows:
Goods
 Supplied within 4 years before registration
 Supplied to the taxable person for business purposes, and
 On hand at the time of registration.
Services
 Supplied in the six months before registration.
 Supplied to the taxable person for business purposes.
Principles of Tax 11: Value Added Tax 113

6 Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you define output VAT and input VAT?

Can you explain the VAT implications of being a trader who makes exempt
supplies compared to one making zero rated supplies?

Do you understand the historic and future prospects tests for VAT registration?

How do we determine the date of a supply of goods for VAT purposes?

Can you give four examples of input VAT incurred by a registered trader that
would not be fully recoverable?
114 11: Value Added Tax Principles of Tax
 115

12

Value Added Tax – further

aspects

Topic List
1. Accounting for VAT
2. Small business reliefs
3. VAT records and accounts
4. Knowledge diagnostic

Learning Objectives
 Identify the records which companies and individuals must retain for tax purposes
 Determine, in straightforward cases, due dates for businesses' VAT returns and payments
 Calculate the monthly, quarterly or annual VAT payable or repayable by a business
 State the alternative schemes for payment of VAT by businesses and calculate the VAT payable
or repayable for a business using these
116 12: Value Added Tax – further aspects Principles of Tax

1 Accounting for VAT

1.1 VAT periods
The period covered by a VAT return is called a VAT period or tax period.
 Normally the VAT period is a three-month period
 One month VAT period where input tax regularly exceeds output tax i.e. where the taxable
person is in a net VAT repayment position.
 Small businesses may submit an annual VAT return (see later in this chapter).

1.2 VAT return

The VAT return (Form VAT100) must be submitted to HMRC using the online system not later than 7
calendar days after the last day of the month following the end of the return period.
Tax due must be paid at this date unless tax is paid by direct debit when it is automatically collected a
further 3 working days after the filing date.
Businesses which file annually or make payments on account have special due dates for their returns
and payments.

INTERACTIVE QUESTION: VAT DUE

F Ltd is a manufacturing company. For the quarter to 30 September, the following information is given
(all excluding VAT):
£ £
Sales (standard rated) 134,285
Sales (zero rated) 12,500
146,785
Purchases 37,750
Wages 23,000
Bad debt written off 1,500
UK customer entertaining 750
Staff entertaining 14,464 (77,464)
Profit 69,321

All purchases and entertaining expenses are standard rated. The bad debt, in respect of a standard
rated supply, was written off in August. The payment for the original sale was due on 31 January.
Requirement
What is the VAT payable for the quarter and when is it due for payment?
SOLUTION
Principles of Tax 12: Value Added Tax – further aspects 117

EXAM SMART
When calculating the VAT liability, the recoverable input VAT must be netted off against the
output VAT on supplies made.
 Look at each supply made and decide if VAT applies to it and at what rate
 Check whether the amounts given as net or gross figures
 Review the input VAT suffered and decide whether it is recoverable, if so deduct from
output VAT

INTERACTIVE QUESTION: TAX POINT AND ACCOUNTING FOR VAT

Jason has the following standard rated sales during the quarter ended 30 June:
Order 1
Goods dispatched on 2 March. Invoice issued on 25 March for £1,200 plus VAT. Payment was received
on 12 June.
Order 2
Goods dispatched on 28 March. Invoice issued on 10 April for £680 plus VAT. Payment was received on
7 July.
Requirement
What is the VAT payable for the quarter ended 30 June and when is it due for payment?
SOLUTION
Order 1
Basic tax point …………………………………………………..
Actual tax point…………………………………………………..

Order 2
Basic tax point …………………………………………………..
Actual tax point…………………………………………………..
Vat payable for quarter 2……………………………………
Due date for VAT………………………………………………..

Since 1 April 2019, the Making Tax Digital for Business (MTDfB) requirements have applied to any
business which has annual taxable turnover above the VAT registration threshold of £85,000. From
April 2022, MTDfB for VAT applies to all VAT-registered businesses.
Initially the requirements apply for VAT purposes only, although businesses, including those beneath
the registration threshold, may use MTDfB on a voluntary basis for both VAT and income tax.
118 12: Value Added Tax – further aspects Principles of Tax

Businesses using MTDfB must:

 keep their records digitally for up to six years; and
 provide their VAT return information to HMRC through MTDfB compatible software which pulls
the data correctly from the businesses digital records.

1.3 Payments on account

Substantial traders are taxable persons with an annual VAT liability in excess of £2.3m. A substantial
trader must make electronic payments on account of VAT for each quarter. Payments are due at the
end of the second and third months of the quarter. The amount of each payment is 1/24 of the total
VAT liability for the previous year.
The final payment is due on the usual due date, i.e. the end of the month following the end of the
quarter. This is submitted with the VAT return.

2 Small business reliefs

2.1 Annual accounting scheme
Businesses submit one VAT return every 12 months.
The VAT return is due within two months of the end of the year.

Conditions
 The value of taxable supplies (excluding VAT and supplies of capital items) in the following year
is not expected to exceed £1.35m. Once a business has joined the scheme it can remain until
taxable supplies in the previous 12 months exceed £1.6m.
 Businesses using the annual accounting scheme make nine equal monthly payments on account
of 1/10 of the previous year’s VAT liability or current year’s estimated liability if registered for
less than 12 months.
 Alternatively, three quarterly payments on account can be made, being 25% of the previous
year’s VAT liability or current year’s estimated liability if registered for less than 12 months.
 The first payment is due at the end of the fourth month, and further payments made either
monthly or quarterly depending on the payment option chosen. Payments must be made
electronically.
 Any balancing payment is due when the VAT return is made, i.e. within two months of the end
of the year.

INTERACTIVE QUESTION: ANNUAL ACCOUNTING SCHEME

W Ltd joined the annual accounting scheme two years ago and elected to make monthly payments. W
Ltd's total VAT liability for the previous year to 31 May was £12,800.
The actual VAT liability for the current year to 31 May was £16,250.
Requirement
What are the payments on account and balancing payment and in which months are they due?
Principles of Tax 12: Value Added Tax – further aspects 119

SOLUTION

The main advantages of the annual accounting scheme are therefore:

 A reduced number of VAT returns required
 Two months to complete the return and make a balancing payment.
The annual accounting scheme can be used in conjunction with either the cash accounting scheme or
the flat rate scheme.

2.2 Cash accounting scheme

The cash accounting scheme allows businesses to account for VAT on the basis of cash paid and
received, rather than on invoices received and issued.
The main advantages of the scheme are:
 output VAT does not have to be accounted for until payment is received
 automatic bad debt relief since no output VAT is payable if payment is not received
However, note that input VAT cannot be recovered until the business has actually paid the supplier for
purchases.

Conditions
 Small businesses may join the cash accounting scheme if the value of taxable supplies (excluding
VAT and supplies of capital items) in the following year is not expected to exceed £1.35m.
 Once a business has joined the scheme it may continue to use it until the value of taxable
supplies in the previous twelve months exceeds £1.6m.
 The business must have submitted all its VAT returns to date and paid all outstanding VAT.
 It must not have been convicted of a VAT offence or penalty in the previous twelve months.

2.3 Flat rate scheme

The flat rate scheme allows businesses to calculate net VAT due by applying a flat rate percentage to
their VAT inclusive turnover rather than accounting for VAT on individual sales and purchases.
The flat rate percentage is set by the type of business carried on. It ranges from 4% (food retailers) to
14.5% (for example, building or construction services where labour only is supplied and accountancy
services). There is a fixed percentage of 16.5% for limited cost traders. There is a 1% reduction during
the first year of VAT registration. For examination purposes, the percentage given in the question will
include this 1% reduction where appropriate.

Conditions
 A business may join the flat rate scheme if the value of its annual taxable supplies (excluding
VAT) does not exceed £150,000.
 If a business has total annual income (inclusive of VAT) in excess of £230,000 it must leave the
flat rate scheme. This condition includes exempt income.
120 12: Value Added Tax – further aspects Principles of Tax

The main advantages of the scheme are:

 reduction of admin – no records of input VAT need be kept
 frequently less VAT payable to HMRC than under the normal rules
The flat rate percentage is set by the type of business carried on (the percentage will be given in the
question.)
The business will issue tax invoices using the normal rules e.g. standard rate, zero rate. It does not
have to keep records of the input VAT on individual purchases.
The VAT payable to HMRC at the end of the VAT period is the flat rate percentage multiplied by the
VAT inclusive turnover for the period. There is no deduction for input VAT. The VAT inclusive turnover
includes taxable supplies, exempt supplies and supplies of capital assets.

INTERACTIVE QUESTION: FLAT RATE SCHEME

Leon uses the flat rate scheme for his business. He has been registered for VAT for five years, making
standard rated supplies. The flat rate percentage is 9 %.
In the quarter to 30 June, Leon had the following transactions:
£
Sales 25,200
Purchases 7,100
Expenses 2,500
All figures exclude VAT.
Requirement
What is the VAT due for the quarter?
SOLUTION
Principles of Tax 12: Value Added Tax – further aspects 121

3 VAT records and accounts

3.1 Records
HMRC requires a taxable person to keep ‘adequate’ records and accounts of all transactions to support
both output VAT charged and the claim for recoverable input VAT.
The main records to be kept should include:
 Order and delivery notes
 Purchase invoices, copy sales invoices and credit notes
 Purchase and sales day books
 Records of daily takings (e.g. till rolls)
 Cash book
 Bank statements and paying-in slips
 Annual accounts (P&L account and Balance Sheet)

3.2 VAT invoices

The VAT invoice is the key record to support a claim to recover input VAT and must therefore be issued
when a taxable person makes a taxable supply to another taxable person.
If the supply is to a customer who is not a taxable person, it is not necessary to issue a VAT invoice, but
in practice VAT invoices are usually issued to all customers.
A full VAT invoice must show the word “invoice” and must contain a number of details:
 A unique identification number
 The business name and address and contact information
 The name and address of the customer
 A clear description of the goods or service
 The date of invoice and the tax point if different
 The price quantity and VAT rate for each item
 Any discount offered
 The amount charged excluding VAT
 The total VAT charged
A ‘simplified’ (less detailed invoice) can be issued if the consideration does not exceed £250.
A ‘modified’ invoice can be issued for retail supplies over £250.
122 12: Value Added Tax – further aspects Principles of Tax

4 Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Do you know how to compute VAT payable for a period?

Do you know when a VAT return needs to be filed and the associated liability paid?

Can you determine the filing date and payment dates under the annual accounting
scheme?

Do you understand how a trader using the flat rate scheme calculates their VAT
liability?

Do you know what records need to be kept for VAT purposes, and for how long
they must be retained?
 123

13

Administration of tax

Topic List
1. Income tax and Capital Gains Tax – returns and payment
2. Corporation tax – returns and interest
3. Pay As You Earn (PAYE) – Real time information (RTI)
4. Value added tax –penalties and interest
5. The common penalty regime
6. Record keeping
7. Making tax Digital for Businesses (MTDfB)
8. Compliance checks and appeals
9. HMRC powers
10. Dishonest conduct by tax agents
11. Business Payment Support Service
12. Budget payment plans
13. Knowledge diagnostic

Learning Objectives
 Identify the records which companies and individuals must retain for tax purposes, the method
of retention and state the periods for which the records must be retained
 Identify the key features of the self-assessment system, including digital tax accounts for both
companies and individuals
 Determine, in straightforward cases tax due dates
 Identify and calculate the interest and penalties
 Identify the periods within which HMRC can enquire into a taxpayer's returns
124 13: Administration of tax Principles of Tax

EXAM SMART
COVID-19
Several temporary measures have been introduced as a result of the COVID-19 pandemic.
For 2023 exams the majority of the temporary measures are not examinable and are not
covered within this material. Exam questions should be based on the rules explained within
this chapter.

EXAM SMART
The Administration section of the tax tables, available throughout your exam is particularly
detailed covering the following topics:
 Submission dates
 Payment dates
 Penalties – Record keeping / Individuals / Companies / PAYE / VAT / Incorrect returns /
Failure to notify

1 Income Tax and Capital Gains Tax – returns and payment

1.1 Issue of tax return
 Some taxpayers do not need to submit a tax return (e.g. employees whose tax is collected at
source under PAYE)
 In April each year HMRC issues tax returns / notices to file to taxpayers likely to need to submit
a return. A taxpayer must file a return if HMRC ask him to.
 Any taxpayer who has a liability to income tax or capital gains tax must notify chargeability
before 5th October following the end of the tax year.

1.2 Types of return and assessment

Full tax return (SA100) Short tax return Simple assessment
Description This covers different types of HMRC may send a short return HMRC can make an
income and gains and includes a which requires limited assessment of a
calculation section. information from the taxpayer. taxpayer’s tax liability
without the need for a
The taxpayer can calculate the May be sent to non-Director
return.
tax themselves or leave it for employees, pensioners or sole
HMRC to calculate traders with turnover of This may be done for
< £85,000 employees whose tax
due cannot be
collected through the
tax code, or taxpayers
receiving state
pension > the personal
allowance
Principles of Tax 13: Administration of tax 125

Full tax return (SA100) Short tax return Simple assessment

Filing Electronic return online, later of: Electronic return online, later of: N/A
deadlines  31 Jan after the tax year  31 Jan after the tax year
 3 mths after return issued  3 mths after return issued
Paper return, later of: Paper return, later of:
 31 Oct after the tax year  31 Oct after the tax year
 3 months after return issued  3 mths after return issued

Payment dates are given in the tax tables accessible in the exam software

1.3 Partnership tax returns

 Although a partnership is not itself liable to tax on the income and gains of the partners, it is
important for partnership income and gains to be reported to HMRC so that these can be
checked against the partners' individual returns.
 A partnership therefore submits a tax return to HMRC in the same way as individuals. The
partners are then taxed on their share of the partnership profit via their own self-assessment
tax return

1.4 Amending tax returns

 HMRC may amend a taxpayer’s return for obvious errors within 9 months of the filing date
 The taxpayer can amend their return within 12 months of the later of:
– 31 January after the end of the tax year
– 3 months after the return was issued

1.5 Payment dates

The following table summarises the typical payment deadlines for Income tax, Class 2 and 4 NIC and
Capital Gains Tax:
Payment Date How is it calculated?
1 payment on account
st
31 January in the tax year Each payment on account is half of the income
2nd payment on account 31 July after the end of the tax and Class 4 NIC paid under self-assessment
tax year for the previous year (i.e. not paid at source)

Balancing payment 31 January after the end of This is the balance of what’s owed:
the tax year  Income tax liability ADD
 Class 2 NIC liability ADD
 Class 4 NIC liability ADD
 CGT liability LESS
 Payments on account
126 13: Administration of tax Principles of Tax

The timeline below shows the payment dates for 2022/23. Note that 31 January each year involves 2
payments – the balancing payment for the prior tax year and the 1st payment on account for the current tax
year

22/23

6/4/22 31/1/23 5/4/23 31/7/23 31/1/24

21/22 Bal. payment

22/23 1st PoA 22/23 2nd PoA 22/23 Bal. payment
23/24 1st PoA

Payments on account are not required where the amount of the tax paid under self-assessment in the
previous year was less than:
 £1,000; or
 20% of the total tax liability (income tax and Class 4 NIC)
Where the taxpayer is an employee and has underpaid tax of less than £3,000, the underpayment will
usually be collected by adjusting their PAYE code for the following tax year.
Payment dates are given in the tax tables accessible in the exam software

INTERACTIVE QUESTION: SELF-ASSESSMENT PAYMENTS

Josiah is a sole trader who paid tax as follows in 2021/22:

£
Total income tax liability 18,400
Tax deducted under PAYE 6,400
Class 4 NICs 3,800
CGT liability 3,000
Payments on account 15,000

Requirement
What payments does Josiah have to make on 31 January 2023 and 31 July 2023?
SOLUTION
Principles of Tax 13: Administration of tax 127

1.6 Unpaid and late-paid tax

 Unpaid tax due can be collected from employees by adjusting their PAYE code for the following
tax year (if the return is filed on paper by 31 October after the tax year, or online by 30
December following the tax year)
 Unpaid tax from earlier years can also be collected by adjusting an employee’s PAYE code
(maximum collection of £17,000)

1.7 Penalties for late filing of self-assessment tax returns

Length of delay Penalty
1 day £100 fixed penalty
3 months £10 per day for a maximum of 90 days, in addition to the £100 fixed penalty
6 months Greater of 5% of the tax liability and £300, and above penalties

After 12 months:
Deliberate and concealed Greater of 100% of tax payable under self-assessment or £300
Deliberate not concealed Greater of 70% of tax payable under self-assessment or £300
Other, e.g. carelessness Greater of 5% of tax payable under self-assessment or £300

1.8 Penalties for late payment of tax by individuals

A penalty may be charged on late payment of:
(1) Balancing payments under self-assessment
(2) Additional tax payment arising from amendments to a self-assessment
(3) Tax payable under a discovery assessment (see later in this chapter)
Note that penalties do not apply to payments on account.
Length of delay Penalty
More than 1 month late 5% of tax unpaid at penalty date
More than 6 months late Additional 5%
More than 12 months late Additional 5%

Late payment penalties can be suspended where the taxpayer agrees a time to pay arrangement,
unless he abuses the arrangement.

INTERACTIVE QUESTION: SELF-ASSESSMENT PENALTIES

Matt gives you the following information about his 2021/22 tax payments and filings:
 First payment on account of £2,000 paid in full on 31 March 2022
 Second payment on account of £2,000 paid in full on 31 July 2022
 Balancing payment of £3,000 paid in full and self-assessment tax return submitted on 30
September 2023

Requirement
Calculate any penalties due.
128 13: Administration of tax Principles of Tax

SOLUTION

1.9 Interest on late paid tax

 Interest is payable on late payments on account, balancing payments, penalties and surcharges
 The interest runs from the due date of payment to the day the payment is made (HMRC does
not include the actual due date or the date the payment is made).

1.10 Interest on overpaid tax

 Repayment interest is payable by HMRC on overpaid payments on account, balancing payments
and penalties.
 Interest runs from the original date (or due date if later) of payment to the day before the
payment is made.
 Repayment interest is exempt from income tax.

2 Corporation Tax – returns and interest

2.1 Notice of chargeability and the tax return
 Companies must give notice to HMRC within 3 months of the start of their 1st accounting period
 Companies must notify HMRC that it has taxable profits within 12 months of the end of an
accounting period (if a notice requiring a return hasn’t been issued to them)
 A full corporation tax return (CT600) must be submitted within twelve months of the end of the
period of account.
 Companies must file online and supporting computations and accounts must be submitted
using iXBRL (Inline eXtensible Business Reporting Language).
 The company may amend their return within 12 months of the filing due date
 Companies must make any claims for overpayment relief on a return within 4 years of the end
of the accounting period

2.2 Corporation tax payment dates

As we saw in chapter 10, there are 3 options for corporation tax payment dates:
Standard Large companies Vary large companies
Threshold Augmented profits ≤ £1.5m £1.5m < Profits ≤ £20m Augmented profits > £20m
Payment 9 months and 1 day after end 14 of months 7,10,13,16 of
th
14th of months 3,6,9,12 of the
dates of accounting period the accounting period accounting period
Principles of Tax 13: Administration of tax 129

2.3 Corporation Tax – interest

 Interest on late paid corporation tax runs from the date the tax should have been paid until the
date it is actually paid and is an allowable non-trading loan relationship debit
 Repayment interest on overpaid corporation tax runs from the later of the date the tax was
originally paid and the date the tax was due to be paid and is a taxable non-trading loan
relationship credit

2.4 Penalties for late filing of corporation tax returns

Offence Penalty
Return ≤ 3 months late £100 penalty (£500 if persistent  late 3 times running)
Return > 3 months late £200 penalty (£1,000 if persistent)
Return filed 18-24m after Penalty of 10% of tax due (in addition to above fixed penalties)
accounting period (6-12m late)
Return filed >24m after Penalty of 20% of tax due (in addition to above fixed penalties)
accounting period (> 12m late)

There are no separate penalties for late corporation tax payments

Payment dates, filing dates and late filing penalties are given in the tax tables accessible in the exam
software

INTERACTIVE QUESTION: CORPORATION TAX – LATE FILING

Kay plc makes up accounts to 30 June each year and is not required to pay corporation tax by
instalments.
For the year to 30 June 2021, Kay plc submitted its tax return and paid its full corporation tax of
£50,000 on 1 February 2023.
Previous returns have been submitted on time

Requirement
What is the maximum penalty payable by Kay plc?
SOLUTION

3 Pay As You Earn (PAYE) – Real time information (RTI)

3.1 Real time information
 Employers must report to HMRC every time a payment is made to an employee.
 The report (Full Payment Submission – FPS) is produced by payroll software and includes the
amount paid, deductions and starter/ leaver dates.
130 13: Administration of tax Principles of Tax

 All benefits, except employer provided living accommodation and interest free/low interest
loans, can be processed through the payroll (‘voluntary payrolling of benefits), with the benefit
value reported in the RTI system
 The FPS should be submitted on or before pay day and the employer must pay their PAYE and
NICs liabilities normally electronically by 22nd of the month following the payroll month
 In addition the employer may have to submit an Employer Payment Summary (EPS) to reconcile
any differences from the FPS

3.2 PAYE forms

The PAYE system has many forms which are used to provide information to enable tax to be calculated
correctly. These have been reduced following the introduction of RTI above.
Name Function Important dates
P11D End of year form recording details of benefits Send to HMRC and copy to employee by 6 July
provided to employees following end of tax year
P60 End of year form recording details of gross Supply to each employee by 31 May following
pay, tax deducted and NICs for both end of tax year
employer and employee
P45 Particulars of employee leaving: recording Given to employee for his own records. (Leavers
tax code, gross pay to date, tax and NICs information is supplied to HMRC under RTI)
deducted

3.3 PAYE penalties – late returns / submissions

Penalties are charged if a business’s Full Payment Submissions are late:
Number of employees Monthly penalty
1–9 £100
10 – 49 £200
50 – 249 £300
≥ 250 £400

If the submission is more than 3 months late, then an additional penalty of 5% of tax and NIC that
should have been reported is due.
Additionally, there is an extra £300 penalty per late P11D return, plus £60 per day if delay continues.

3.4 PAYE penalties – late payment

The penalties charged are dependent on the number of late payments in the tax year:
No. of late payments Penalty (% of tax unpaid)
1 st
Nil
2 ,3 ,4
nd rd th
1%
5th, 6th, 7th 2%
8th, 9th, 10th 3%
11 , 12
th th
4%

 If the tax remains unpaid at 6 months, a further penalty of 5% of tax is applied

 A further 5% penalty is applied if the tax remains unpaid at 12 months
Late submission and payment penalties are given in the tax tables accessible in the exam software
Principles of Tax 13: Administration of tax 131

4 Value added tax – penalties and interest

4.1 Penalty for late filing of VAT returns
As we saw in chapter 11, the deadline for filing VAT returns and paying VAT owed is 7 days after the
month following the end of the return period.
 There is a new penalty regime for late submission of VAT returns applicable to returns for
periods beginning on or after 1 January 2023. Only these new rules are examinable in 2023.
 The late submission penalties are points-based. Businesses will receive a point each time a VAT
return is submitted late. These points are accumulated and once a penalty threshold (see
below) has been reached a £200 penalty is charged. A further £200 penalty is then charged each
time a VAT return is late, although no further points accrue.
VAT return submission frequency Penalty threshold
Monthly 5 points
Quarterly 4 points
Annually 2 points

 Unless the penalty threshold has been reached, these points expire after two years. The expiry
deadline is calculated from the start of the month after the month in which the late submission
occurred, as follows:
VAT return period (example) Due date Penalty expiry date
Monthly - 30 April 2023 7 June 2023 1 July 2025
Quarterly - 31 March 2023 7 May 2023 1 June 2025
Annually - 31 January 2024 31 March 2024 1 April 2026

 However, if the business has reached the penalty threshold, the points do not expire after two
years and instead, can only be reset to zero when both:
– the business has submitted all its VAT returns on time for the relevant period of
compliance (see below); and
– all the VAT returns for the previous 24 months have now been submitted.
The required period of compliance depends on the frequency of VAT returns:
VAT return submission frequency Period of compliance
Monthly 6 months
Quarterly 12 months
Annually 24 months
132 13: Administration of tax Principles of Tax

WORKED EXAMPLE: LATE SUBMISSION OF VAT RETURN

Tabitha submits her VAT returns late for periods ending 31 March 2023, 30 June 2023, 30 September
2023 and 31 December 2023 and so she accrues four points.
As Tabitha has reached the penalty threshold for quarterly returns her points do not automatically
expire after two years. Instead to reset her points to zero, Tabitha must:
– submit returns on time for the quarterly period of compliance ie the twelve months
commencing 1 January 2024 (returns for quarters ending 31 March, 30 June,
30 September and 31 December 2024); and
– ensure that all the returns for the previous 24 months have been submitted ie all the
returns for the 2 years ending 31 December 2024.
If these conditions are met, Tabitha’s points will be reset to zero on the date she submits the last
return in the compliance period ie the 31 December 2024 return, by 7 February 2025.

INTERACTIVE QUESTION: LATE SUBMISSION OF VAT RETURN

Joshua files quarterly VAT returns. He has filed the last four VAT returns late and has therefore accrued
his fourth point by submitting his return for 31 December 2023 late.
Requirement
What penalties will he be liable for, and when will his penalty points be reset to zero if he also submits
his return for the quarter ended 31 March 2024 late, but then submits further returns on time?
SOLUTION

4.2 Penalty for late payment of VAT

There is a new penalty regime for late payment of VAT applicable to payments relating to periods
beginning on or after 1 January 2023. Penalties may apply to payments on account and payments due
under the annual accounting scheme, as well as amounts due on VAT returns. Only these new rules
are examinable in 2023.
 To stop a penalty from accruing taxpayers can ask HMRC to agree a Time-to-Pay (TTP)
arrangement.
 There are two late payment penalties that may apply:
– A first penalty based on the amount outstanding in the first 30 days after the due date:
and
Principles of Tax 13: Administration of tax 133

– Then an additional or second penalty, with an annualised penalty rate for any amount
still outstanding 30 days after the due date.
Days since payment due date Action by taxpayer Penalty
By day 15 either payment is made or
Days 0 - 15 TTP arrangement has been proposed No penalty
(and subsequently agreed)
By day 30 either payment is made or
First penalty of 2% × amount
Days 16 - 30 TTP arrangement has been proposed
outstanding
(and subsequently agreed)
Tax is still unpaid, no TTP agreed First penalty of 2% x amount
Day 30 outstanding on day 15 plus 2% ×
amount outstanding on day 30
Tax is still unpaid, no TTP agreed Second penalty at 4% pa
Day 31 onwards calculated on a daily basis on
amount outstanding

HMRC have stated that during the first year of the new regime from 1 January 2023, no “first” late
payment penalties will be applied provided all VAT is paid in full within 30 days of the due date. In the
exam, questions testing calculations of late payment penalties will all be for returns in 2024, so you
can ignore this relaxation of the rules.

WORKED EXAMPLE: LATE PAYMENT OF VAT

(a) Gate Ltd was 55 days late paying the VAT due of £1 million for its quarter ended 31 March 2024.
Requirement
What is the total penalty payable for late payment of its VAT liability?
SOLUTION
The first penalty is the £1 million outstanding on day 15 at 2%. A further 2% is due on the
amount outstanding at day 30. The total first penalty will therefore be:
2% + 2% = 4% × £1,000,000 = £40,000
In addition, a second penalty is payable from day 31 onwards at 4% pa calculated on a daily
basis of the amount still outstanding:
4% × £1,000,000 × 25/365 = £2,740
The total penalty payable is therefore £42,740.
(b) Wall Ltd had a VAT liability of £1 million for its quarter ended 31 March 2024. Wall Ltd paid
£250,000 of the total due 21 days late and paid the remaining £750,000 40 days late.
Requirement
What is the total penalty payable for late payment of its VAT liability?
SOLUTION
The first penalty is the £1 million outstanding on day 15 at 2% plus a further 2% of the £750,000
outstanding on day 30. The total first penalty will therefore be:
(2% × £1,000,000) + (2% × £750,000) = £35,000
In addition, a second penalty is payable from day 31 onwards at 4% pa calculated on a daily
basis of the amount still outstanding:
4% × £750,000 × 10/365 = £822
134 13: Administration of tax Principles of Tax

The total penalty payable is therefore £35,822.

(c) Fence Ltd was unable to pay its VAT liability of £1 million for its quarter ended 31 March 2024. It
took until day 25 after the due date for Fence Ltd to propose a Time-to-Pay arrangement to
HMRC.
Fence Ltd agreed with HMRC that it would pay the VAT liability in full 100 days late when it
receives payment from a large credit customer.
Requirement
What is the total penalty payable for late payment of its VAT liability?
SOLUTION
The first penalty is the £1 million outstanding on day 15 at 2%. The proposal of the TTP
arrangement before day 30 means that the second part of the first penalty is not due even
though the VAT is still outstanding on day 30. The first penalty is therefore:
2% × £1,000,000 = £20,000
No second penalty is due even though the VAT was not paid by day 31, because of the TTP
arrangement.
The total penalty is therefore £20,000.

4.3 VAT errors

The common penalty regime for errors on returns apply to VAT returns as well as the following rules.
 An error on a vat return can be corrected on the next return provided that it was not deliberate
and does not exceed the greater of
– £10,000 or
– 1% of net VAT turnover for a return period (max £50,000)
 Large or deliberate errors should be notified on Form VAT652
 Penalties will not be due if the trader can show reasonable excuse.
VAT penalties and rules on VAT errors are given in the tax tables accessible in the exam software

5 The common penalty regime

5.1 Taxes and offences covered
In this chapter we have seen that penalties for certain offences (such as late filing and late payment)
are different for different taxes.
However, legislation has been introduced to standardise penalties for the following offences and taxes
Tax Penalty
Income Tax and CGT Failure to notify HMRC of chargeability
National Insurance Contributions Incorrect returns (errors)
Corporation Tax
VAT
Principles of Tax 13: Administration of tax 135

5.2 Behaviour and penalties

 Penalties under the common regime are based on Potential Lost Revenue (PLR) and range from
30% to 100% of PLR.
 The PLR is calculated as the net loss to HMRC.
 A penalty will be imposed where the taxpayer’s behaviour can be classified as:
Behaviour Description
Careless The taxpayer has not taken reasonable care in completing the return
Deliberate but not concealed The taxpayer has e.g. deliberately made an inaccurate return but has
not done anything to conceal the inaccuracy
Deliberate and concealed The taxpayer has e.g. deliberately made an inaccurate return and done
something to conceal the inaccuracy (such as producing false invoices
or bank statements)

 In order for a penalty to be charged, the inaccurate return must result in:
– an understatement of the taxpayer’s tax liability; or
– a false or increased loss for the taxpayer; or
– a false or increased repayment of tax to the taxpayer
 The penalties for each offence can be mitigated if the taxpayer makes a disclosure to HMRC and
will depend upon whether the disclosure is “prompted” or “unprompted.”

5.3 Failure to notify chargeability

As previously stated:
 Individuals must notify HMRC of chargeability by 5 October after the end of the tax year
 Companies must notify HMRC within 3 months of the start of their first accounting period and
within 12 months of the end of an accounting period with taxable profits (if a notice to file
hasn’t been received)
 The rules on VAT registration are covered in chapter 11
The penalties for failure to notify are:
Maximum Minimum penalty with Minimum penalty with prompted
Behaviour
penalty unprompted disclosure disclosure
Deliberate and
100% of PLR 30% of PLR 50% of PLR
concealed
Deliberate, not
70% of PLR 20% of PLR 35% of PLR
concealed
>12 mths <12 mths >12 mths <12 mths
Careless 30% of PLR
10% of PLR Nil 20% of PLR 10% of PLR
136 13: Administration of tax Principles of Tax

5.4 Penalties for incorrect returns

Maximum penalty for Unprompted Prompted
Type of error
failing to disclose error disclosure disclosure
Careless 30% of PLR 0% of PLR 15% of PLR
Deliberate, not
70% of PLR 20% of PLR 35% of PLR
concealed
Deliberate and concealed 100% of PLR 30% of PLR 50% of PLR

Failure to notify and inaccurate return penalties are given in the tax tables accessible in the exam
software

5.5 Failure to send a return

The maximum penalty payable where tax has been under-assessed because the taxpayer has failed to
send a return is 30% of Potential Lost Revenue (in addition to late filing penalties)

5.6 Issue of penalty and appeal

 If a person is liable to a penalty, HMRC will send a penalty assessment. This states what they
owe, and that the penalty must be paid within 30 days.
 In some cases the penalty may be suspended (but not if it relates to deliberate behaviour). A
taxpayer has the right to appeal against the imposition of the penalty or the level of the penalty.

INTERACTIVE QUESTION: COMMON PENALTY REGIME

Graham is a sole trader. He files his tax return for 2022/23 on 31 January 2024. The return shows
trading income of £65,000, but Graham decided not to disclose £12,000 of property income.
HMRC initiates a compliance check into Graham's return and Graham discloses the £12,000 of
undisclosed property income.
Previous returns have been submitted on time.
Requirement
State the maximum and minimum penalties that Graham could be charged by HMRC for his error.
SOLUTION
Principles of Tax 13: Administration of tax 137

6 Record keeping
Adequate records to support your tax returns must be kept for the following time periods.
Tax Time limit
Corporation tax 6 years from end of accounting period
Income and capital gains tax Business - 5th anniversary of 31 January following end of tax year
Other - 1st anniversary of 31 January following end of the tax year
VAT 6 years

Penalties for each failure to keep records (£3,000 per tax year for each failure) are given in the tables.

6.1 Time limits for taxpayer claims

The general time limit for taxpayers making claims, which applies in the absence of any specific time
limit, is four years from the end of the tax year or accounting period.

6.2 Duties of senior accounting officers

Senior accounting officers of ‘qualifying’ companies must take reasonable steps to establish and
maintain appropriate tax accounting arrangements.
A qualifying company has, at the end of its previous financial year:
(a) turnover of more than £200 million, and/ or
(b) a balance sheet total of more than £2 billion
Qualifying companies must notify HMRC of the name of their senior accounting officer (SAO). The SAO
must certify annually that the company’s accounting systems are adequate for the purposes of
accurate tax reporting.
The SAO may be liable to a £5,000 penalty, in each of the following cases, for his failure to:
(a) Establish and maintain appropriate tax accounting arrangements.
(b) Provide an annual certificate to HMRC or provide a certificate that contains a careless or
deliberate inaccuracy.
HMRC may impose a £5,000 penalty on the company for failure to notify the name of the SAO.

7 Making Tax Digital for Businesses (MTDfB)

The Government has stated it intends to introduce digital record keeping and updating and the use of
MTDfB-compliant software to submit tax returns.
Once fully implemented it will apply for all businesses (both companies and unincorporated
businesses), the self-employed and landlords.
From 1 April 2022, MTDfB will apply to all VAT-registered businesses for VAT purposes
Businesses using MTDfB must:
 keep their records digitally for up to six years; and
 provide VAT return information through MTDfB compatible software.
138 13: Administration of tax Principles of Tax

8 Compliance checks and appeals

8.1 Compliance checks
HMRC has the power to conduct a compliance check into an individual’s or company’s tax return.
Some returns are selected for enquiry at random, others for a particular reason.
Notice must be given by HMRC of the intention to conduct an enquiry by:
 The first anniversary of the actual submission date; or
 If the return is filed after the due submission date, the quarter day following the first
anniversary of the actual submission date. The quarter days are 31 January, 30 April, 31 July and
31 October.
Only one formal enquiry into a tax return is possible.

8.2 Determinations
Where a return is not received HMRC may make a determination of the tax due within 3 years of the
statutory filing date. This is treated as a self-assessment to determine payments interest and penalties
due unless it is displaced by a self-assessment.

8.3 Discovery assessments

HMRC can also make a discovery assessment after the usual time for enquiries if it is discovered that
full disclosure has not been made by the taxpayer.
If the reason for the discovery assessment is that the taxpayer has made an incomplete disclosure
resulting in a loss of tax, the time limits for a discovery assessment are:
 Not due to careless or deliberate behaviour – 4 years
 Due to ‘careless’ behaviour – 6 years
 Due to ‘deliberate’ behaviour – 20 years
The time periods run from:
– The end of the tax year (income tax and CGT)
– The end of the accounting period (corporation tax)
– The prescribed accounting period (VAT)

8.4 Appeals
A taxpayer may make an appeal against:
 A request by HMRC to submit documents, supporting records etc. in the course of a compliance
check
 Amendments made to a self-assessment as the result of a compliance check
 HMRC's right to raise a discovery assessment
 A discovery assessment
 A VAT assessment
 Imposition of a penalty or surcharge
The appeal must be made in writing within 30 days of the relevant event and must specify the grounds
for the appeal.
Principles of Tax 13: Administration of tax 139

9 HMRC Powers
9.1 Information powers
 HMRC have the power to request information and documents either informally from the
taxpayer or formally via a “written notice” from the taxpayer or from a third party provided
that the documents are “reasonably required” to check the tax position.
 Third party notices must have the consent of either the taxpayer or the First Tier Tribunal
unless the information relates only to statutory VAT records. The taxpayer must be given
details unless HMRC believe this would prejudice the collection of tax.
 Note that tax advisers need not provide their working papers or communications between the
tax adviser and the client. Auditors cannot be asked to provide information connected with the
audit function.

9.2 Inspection powers

An authorised HMRC officer can enter the business premises of a taxpayer whose liability is being
checked and inspect the premises, the business assets, and business documents on the premises.
There is no right of appeal against an inspection notice.

10 Dishonest conduct by tax agents

This is a provision where HMRC has evidence that a tax agent (someone acting in the course of their
business) has done something dishonest leading to a loss of tax.
Consequences are
 A civil penalty of between £5,000 and £50,000
 A conduct notice
 Access to the working papers of the tax agent (with further penalties of £300 and daily penalties
of £60 for failure to comply)
 Publish information about the tax agent (if a dishonest conduct penalty exceeds £5,000)
 Report the agent to their professional body.

11 Business Payment Support Service

A Business Payment Support Service (BPSS) is in place to assist businesses which are unable or
anticipate they will be unable to meet income tax, national insurance, corporation tax, VAT or other
payments owed to HMRC.
The service reviews the circumstances of the business and may arrange temporary options such as
arranging for payments to be made over a longer period.
Interest will continue to be payable as applicable.

12 Budget payment plans

This allows a taxpayer to make Direct Debit payments towards a future tax liability, on a weekly or
monthly basis. The taxpayer must be up to date with previous tax payments and any balance is due on
the usual payment dates.
140 13: Administration of tax Principles of Tax

13 Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you explain the operation of penalties for errors under the Common Penalty
Regime?

Are you familiar with the filing and payment dates for income tax under
self-assessment?

Can you explain the different late filing penalties applicable to individuals and
companies?

Do you know how the late filing and late payment penalties for VAT operate?

Can you explain what powers HMRC have when a taxpayer fails to submit a tax
return?
 141

14

Solutions to
Interactive Questions
142 Solutions to interactive questions Principles of Tax

Chapter 1
No examples

Chapter 2
No examples

Chapter 3
Solution: Taxable income
Charlotte
Taxable income
Non-savings Savings Dividend
income income income Total
£ £ £ £
Employment income 11,950
Bank interest 1,625
Dividends 1,500
Net income 11,950 1,625 1,500 15,075
Less personal allowance (11,950) (620) (12,570)
Taxable income Nil 1,005 1,500 2,505

Solution: Reduction of the personal allowance

Julia:
£
Personal allowance 2022/23 12,570
Less (£110,000 – £100,000) = £10,000 × ½ (5,000)
Personal allowance for Julia 7,570

Solution: Income tax liability on non-savings income: Lois

Non-savings
income
£
Employment income/ Net income 169,000
Less: PA (note) (nil)
Taxable income 169,000
Principles of Tax Solutions to interactive questions 143

Tax
£
£37,700 × 20% 7,540
£112,300 × 40% 44,920
£150,000
£19,000 × 45% 8,550
£169,000
Income tax liability 61,010

Note:
As Lois’ net income exceeds £125,140 (£100,000 plus (PA x2)) her personal allowance is restricted to
nil

Solution: Income tax liability on non-savings and savings income: Evie

Income tax liability
Non-
savings Savings
income income Total
£ £ £
Property income 13,150
Building society interest 51,000
Net income 13,150 51,000 64,150
Personal allowance (12,570) (12,570)
Taxable income 580 51,000 51,580
Tax
£
Tax on non-savings income: £580 × 20% 116
Tax on savings income:
– in starting rate band £4,420 × 0% 0
£5,000
– savings income nil rate band £500 × 0% 0
– in savings basic rate band £32,200 × 20% 6,440
£37,700
– in savings higher rate band £13,880 × 40% 5,552
£51,580
Income tax liability 12,108

The £580 of non-savings taxable income is taxed first at 20%, the basic rate of tax for non-savings
income.
Savings income is taxed next on a cumulative basis. Since the taxable non-savings income was less
than £5,000 there is £4,420 of savings income in the starting rate band to tax at 0%.
Evie is entitled to savings income nil rate band of £500 as she is a higher rate taxpayer (taxable income
of £51,580 exceeds £37,700) and so the next £500 of savings income is taxed at the savings nil rate of
0%.
On a cumulative basis a total of £5,500 of taxable income has been taxed so far. This leaves £32,200
(£37,700 – £5,500) of the basic rate band to tax the savings income at the savings basic rate of 20%.
Finally, £13,880 of savings income falls in the savings higher rate band which is taxed at 40%.
144 Solutions to interactive questions Principles of Tax

Solution: Income tax liability on all income: George

Income tax liability
Non-
savings Savings Dividend
income income income Total
£ £ £ £
Employment income 33,795
Bank interest 5,000
Dividends 12,000

Net income 33,795 5,000 12,000 50,795

Personal allowance (12,570) (12,570)
Taxable income 21,225 5,000 12,000 38,225
Tax
£
Tax on non-savings income: £21,225 × 20% 4,245
Tax on savings income:
– in starting rate band £0 × 0% 0
– savings income nil rate band £500 × 0% 0
– in savings basic rate band £4,500 × 20% 900
Tax on dividends: £26,225
– dividend nil rate band £2,000 × 0% 0
– in dividend ordinary rate band £9,475 × 8.75% 829
£37,700
– in dividend upper rate band £525 × 33.75% 177
£38,225
Income tax liability 6,151

Since the taxable non-savings income was more than £5,000 there is no starting rate band remaining
to tax any savings income at 0%. The first £500 of savings income is covered by savings income nil rate
band. (George is a higher rate taxpayer as taxable income of £38,225 exceeds £37,700.) The remaining
savings income falls in the basic rate band and is taxed at the savings basic rate of 20%.
The first £2,000 of dividend income is covered by the dividend nil rate band and so is taxed at 0%. On a
cumulative basis a total of £28,225 of taxable income has been taxed so far. This leaves £9,475
(£37,700 – £28,225) of the basic rate band to tax the dividend income at the dividend ordinary rate of
8.75%.
Finally, £525 of dividend income falls in the dividend upper rate band which is taxed at 33.75%.
Principles of Tax Solutions to interactive questions 145

Solution: Income tax payable on all income: Elise

Income tax payable
Non-
savings Savings Dividend
income income income Total
£ £ £ £

Employment income 95,875

Property income 31,700
Bank interest 26,425
Dividends 17,000
Net income 127,575 26,425 17,000 171,000
Personal allowance (–) (–)
Taxable income 127,575 26,425 17,000 171,000

Tax
£
Tax on non-savings income:
– in basic rate band £37,700 × 20% 7,540
– in higher rate band £89,875 × 40% 35,950
127,575
Tax on savings income:
– in savings higher rate band £22,425 × 40% 8,970
£150,000
– in savings additional rate band
(26,425 – 22,425) 4,000 × 45% 1,800
Tax on dividends:
– in dividend nil rate band £2,000 × 0% 0
– in dividend additional rate band
(17,000 – 2,000) £15,000 × 39.35% 5,903
£171,000
Income tax liability 60,163
Less tax deducted at source (PAYE) (17,575)
Income tax payable 42,588

Since the taxable non-savings income was more than £5,000 there is no starting rate band remaining
to tax any savings income at 0%.
There is no savings income nil rate band as Elise is an additional rate taxpayer.
There is no PA as Net income exceeds £125,140.
146 Solutions to interactive questions Principles of Tax

Solution: Gift Aid: Roz

Roz
Taxable income (all non-savings) £170,000

Tax
£
£39,700 × 20% (working – extended band) 7,940
£112,300 × 40% (extended band) 44,920
£152,000
£18,000 × 45% 8,100
£170,000
Income tax liability 60,960

Working
Basic rate band 37,700
Gift aid (1600 × 100/80) 2,000
39,700

Higher rate band 150,000

Gift aid 2,000
152,000

Solution: Marriage allowance

Josie
Income tax liability £
Net income 20,000
Less personal allowance (12,570)
Taxable income 7,430
Tax
£7,430 × 20% 1,486
Less marriage allowance reduction
£1,260 × 20% (252)
Income tax liability 1,234

Chapter 4
Solution: Receipt of general earnings
Thomas
£
Salary (£2,100 × 12) 25,200
Bonus (received May 2022) 2,250
Taxable earnings 2022/23 27,450
Principles of Tax Solutions to interactive questions 147

Solution: Living accommodation

Kyle
Basic rental benefit
£
Annual value 7,500
Less: rent paid by Kyle (7,500)
Taxable benefit NIL

Additional yearly rental benefit

£
Cost of provision (£150,000 + £15,000) 165,000
Less: lower limit (75,000)
90,000

£90,000 × 2% 1,800
Less: rental paid by Kyle
(£700 × 12) = £8,400 – £7,500 (900)
Taxable benefit 900

Solution: Car benefit

Darren
CO2 emissions are 98g/km, round down to 95g/km
Appropriate percentage:
(95 – 75) = 20g/km in excess of threshold
20 ÷ 5 = 4%
4% + 20% = 24%
£
List price £13,395 × 24% 3,215
Less: contribution for use £50 × 12 (600)
Taxable benefit 2,615

The price actually paid by the employer of £10,395 is irrelevant.

Solution: Fuel benefit

CO2 emissions are 192g/km, round down to 190g/km
Appropriate percentage:
(190 – 75) = 115g/km in excess of threshold
115 ÷ 5 = 23%
20% + 23% + 4% (diesel) = 37% (maximum)
£25,300 × 37% = £9,361

No reduction for partial contribution for private fuel.

148 Solutions to interactive questions Principles of Tax

Solution: Private use assets

(a)
Television
Annual value
20% × £1,100 £220

Available for six months in tax year

£
£220 × 6/12 110
Less: employee contribution £10 × 6 (60)
Taxable benefit 50
Computer
Insignificant private use therefore no taxable benefit £nil
(b)
Computer £
Annual value
20% × £2,700 540
Business use (55%) (297)
Taxable benefit (45%) 243

Solution: Marginal cost

First determine which fee cost is relevant.
The marginal cost of providing the place is the equivalent to the additional cost, ie £1,500.
Then deduct the contribution paid by Leonard ie £2,000
This cannot give rise to a negative benefit, so the benefit is nil.

Solution: PAYE code

Katie
£
Allowance: Personal allowance 12,570
Less: Deduction (taxable benefits) (4,795)
Net allowances 7,775

Katie's tax code is therefore 777L.

Solution: K code
Zack
£
Allowances: Personal allowance 12,570
Less: Deduction (taxable benefits) (12,777)
Net allowances (207)

Deduct the last digit (gives 20) and deduct 1.

Zack's tax code is therefore K19.
Note: As Zack’s benefits relate to living accommodation they cannot be taxed via voluntary payrolling
and so would be reflected in his PAYE code
Principles of Tax Solutions to interactive questions 149

Solution: Unpaid tax

Brandon
Brandon is a basic rate taxpayer £
Allowances: Personal allowance 12,570
Less: Deduction (unpaid tax) £300 × 100/20 (1,500)
Net allowances 11,070

Brandon's tax code is therefore 1107L.

Chapter 5
No examples

Chapter 6
Solution: Writing down allowances
Tyrone
Main pool Allowances
Period of account – period ended 31 December 2022 (7 months) £ £
Acquisitions
1.6.22 Volvo (MV) 5,500
1.9.22 Nissan 6,500
12,000
No disposals
WDA: £12,000 × 18% × 7/12 (time apportioned for 7 month period) (1,260) 1,260
TWDV c/f 10,740

Period of account – year ended 31 December 2023 (12 months)

Acquisitions
No acquisitions

Disposals
1.9.23 Volvo (4,000)
1.11.23 Nissan (scrap proceeds) (250)
6,490
WDA £6,490 × 18% (1,168) 1,168
TWDV c/f 5,322
150 Solutions to interactive questions Principles of Tax

Solution: Annual investment allowance

Jose
Main pool Allowances
Period of account – Year ended 31 December 2022 £ £
TWDV b/f 6,560
Acquisitions
24.8.22 Press 40,000
Less AIA (40,000) 40,000
Disposals
1.6.22 Plant (480)
6,080
WDA @ 18% (1,094) 1,094
TWDV c/f 4,986 41,094

Solution: Cars
Gordon
Main
FYA pool Allowances
£ £
Period of account
Year ended 31.3.23
TWDV b/f 7,600
Acquisitions
car – emissions 0g/km/49g/km 10,300 16,000
10,300 23,600
FYA @ 100%/WDA @ 18% (10,300) (4,248) 14,548
TWDV c/f 0 19,352
Total allowances 14,548

Solution: Assets with private use

Jasper
Computer Car Allowances
£ £ £
Period of account
Year ended 30.4.22
TWDV b/f 2,000
Acquisition (no FYA or AIA) 16,000
WDA @ 18% (360) 288
× 80%
WDA @ 18% (2,880)
× 70% 2,016
TWDVs c/f 1,640 13,120
Allowances 2,304
Principles of Tax Solutions to interactive questions 151

Solution: Balancing adjustments

Phillip
Main pool Ford Audi Allowances
£ £ £ £
Period of account
Year ended 31 March
TWDV b/f 6,250 10,000
Acquisition (no AIA or FYA)
Car 17,500
Disposals
Office equipment (7,200)
(950)
Balancing charge 950 (950)
–
Car (7,500)
2,500
Balancing allowance (2,500) 2,000
× 80%
–
WDA @ 18% (3,150)
× 80% 2,520
TWDV c/f 14,350
Allowances 3,570

If the balancing charge had exceeded the allowances, the excess charge would have been added to the
adjusted trade profit for the year.

Chapter 7
Solution: Basis period
Sasha
The basis period for 2022/23 is the period of account ending 31 December 2022.
Sasha's taxable trading profit for 2022/23 is therefore £15,000

Solution: Second tax year

Ernest
First tax year (2021/22)
Actual basis
Basis period 1 January 2022 to 5 April 2022
3/12 × £12,000 £3,000

Second tax year (2022/23)

12 month period of account ending in 2nd tax year
Basis period 1 January 2022 to 31 December 2022
y/e 31 December 2022 £12,000
152 Solutions to interactive questions Principles of Tax

Solution: Third tax year

Sergio
First tax year (2020/21)
Actual basis
Basis period 1 February 2021 to 5 April 2021
2/15 × £30,000 £4,000

Second tax year (2021/22)

No period of account ending in 2nd tax year
Basis period 6 April 2021 to 5 April 2022
12/15 × £30,000 £24,000

Third tax year (2022/23)

Period of account ending in 3rd tax year more than 12 months
Basis period 1 May 2021 to 30 April 2022
12/15 × £30,000 £24,000

Solution: Final tax year

Darren
Final tax year (2022/23)
End of previous basis period to cessation
Basis period 1 January 2022 to 30 November 2022
11 month p/e 30 November 2022 £6,000
Less overlap (£5,000)
£1,000
Penultimate tax year (2021/22)
CYB
Basis period 1 January 2021 to 31 December 2021
y/e 31 December 2021 £10,000

Solution: Opening and closing years

Ian
First tax year (2018/19)
Actual basis
Basis period 1 August 2018 to 5 April 2019
8/10 × £24,000 £19,200

Second tax year (2019/20)

Period of account in second tax year less than 12 months
Basis period 1 August 2018 to 31 July 2019
10 months to 31 May 2019 £24,000
1 June 2019 to 31 July 2019: 2/12 × £31,000 £5,167
£29,167
Principles of Tax Solutions to interactive questions 153

Third tax year (2020/21)

CYB
Basis period 1 June 2019 to 31 May 2020
y/e 31 May 2020 £31,000

Overlap profits
Period of overlap 1 August 2018 to 5 April 2019 and 1 June 2019 to 31 July 2019
Overlap profits
8/10 × £24,000 £19,200
2/12 × £31,000 £5,167
£24,367
Penultimate tax year (2021/22)
CYB
Basis period 1 June 2020 to 31 May 2021
y/e 31 May 2021 £44,000

Final tax year (2022/23)

End of previous basis period to cessation
Basis period 1 June 2021 to 30 April 2022 £38,000
Less: overlap profits £(24,367)
£13,633

Solution: Partnership
Total Erin Cassandra
£ £ £
Salary 25,000 10,000 15,000
Balance 2:1 30,000 20,000 10,000
Totals 55,000 30,000 25,000

For the year ended 31 March 2023 Erin has taxable trading profits of £30,000 and Cassandra has
taxable trading profits of £25,000. As the partnership is not new this will be taxed on each partner on a
CYB in 2022/23.

Chapter 8
Solution: Class 1 Primary contributions
Meg and Munroe Primary contributions
Meg
(£424 – £190) = £234 × 13.25% £31

Munroe £
(£4,189 – £1,048) = £3,141 × 13.25% = 416
(£4,800 – £4,189) = £611 × 3.25% = 20
Total 436
154 Solutions to interactive questions Principles of Tax

Solution: Class 1 Secondary contributions

Meg – secondary
Meg
(£424 – £175) = £249 × 15.05% £37

Munroe
(£4,800 – £758) = £4,042 × 15.05% £608

If you are required to compute the annual secondary NICs payable by an employer, you can use the
annualised ST of £9,100. In this case, the payment of additional amounts, such as bonuses, will not
affect the calculation since there is no upper earnings limit for secondary contributions and the
secondary threshold remains the same throughout the tax year.

Solution: Class 1 Secondary contributions – young workers

Oliver – Aged 16 - 20
Oliver's weekly wage is below the upper secondary threshold of £967 per week £0
Nora – Aged 16 - 20
(£4,800 – £4,189) = £611 × 15.05% £92
Kieran – Apprentice - Aged 16 - 24
(£4,500 – £4,189) = £311 × 15.05% £47

Solution: Employment allowance

Annual Class 1 secondary per employee:
(£60,000 – £9,100) = £50,900 × 15.05% = £7,660
Total Class 1 Secondary NIC (£7,660 × 3) = £22,980
Less £5,000 employment allowance £17,980

Solution: Class 1A contributions

Beryl
Class 1A
(£810 + £3,500) = £4,310 × 15.05% £649

The vouchers exchangeable for goods are earnings and so will be subject to Class 1 NICs. Pension
advice up to £500 is an exempt benefit.

Solution: Class 2 and 4 contributions

Andreas
Class 2 contributions
Above lower profits limit
52 × £3.15 = £164

Class 4 contributions
(£12 200 – £11,908) = £292 × 10.25% = £30
Principles of Tax Solutions to interactive questions 155

Chapter 9
Solution: Allowable costs
Paul
£ £
Gross sale proceeds 180,000
Less: auctioneers' fees (4,500)
legal fees (1,200)
Net disposal consideration 174,300
Less: acquisition cost 120,000
surveyor's fees 1,500
legal fees 1,000
enhancement expenditure (central heating) 2,000 (124,500)
Chargeable gain 49,800

Note that the repairs to the roof and the redecoration are not capital expenditure and so cannot
qualify as enhancement expenditure. The cost of the sun room is not deductible as enhancement
expenditure because it is not reflected in the value of the cottage at the time of disposal.

Solution: CGT liability

Olly
£
(£37,700 – £29,200) £8,500 × 10% 850
(£21,500 – £8,500) £13,000 × 20% 2,600
CGT liability 3,450

Taxable gains are already net of the annual exempt amount.

Taxable income is net of the personal allowance. Olly has £8,500 of unused basic rate band remaining
and this amount of the taxable gains are taxed at 10%. The remainder of the taxable gains of £13,000
are taxed at 20%.
Alice
£
£17,000 × 10% 1,700

Alice has £29,700 (£37,700 – £8,000) unused basic rate band so her taxable gains are all taxed at 10%

Solution: Chattels – gain

Martin
£ £
Gross proceeds 7,000
Less: costs of sale (350)
Net disposal proceeds 6,650
Less: cost (4,000)
Gain 2,650

Gain cannot exceed 5/3 × £(7,000 – 6,000) 1,667

Therefore chargeable gain on sale 1,667

156 Solutions to interactive questions Principles of Tax

Solution: Chattels – loss

Lucinda
£ £
Gross proceeds (deemed) 6,000
Less: costs of sale (270)
Net disposal proceeds 5,730
Less: cost (8,000)
Allowable loss (2,270)

Solution: Part disposal from a set of chattels

Alex
£ £
Gross sale proceeds 14,000
Less: 10% auctioneers fees (1,400)
Net disposal proceeds 12,600
Less: cost (£45,000 × 14,000/ (14,000 +60,000) (8,514)
Gain 4,086

As the gross proceed of £14,000 and the apportioned cost of £8,514 both exceed the chattels
threshold of £6,000 the special chattels rules will not apply to this disposal.
The remaining cost of £36,486 (£45,000 – £8,514) is carried forward by Alex to offset against any
future disposals of the rest of the dining set.

Solution: Part disposals to connected persons

This is a disposal from a set of chattels to persons connected with each other.
Since the total proceeds are £10,300 (£5,500 + £4,800) marginal relief applies. However, it is
necessary to compute the actual gains on each disposal and you may be required to do this in the
exam.
May
Disposal proceeds 5,500
Less: cost (part disposal) (£2,000 × 5,500/ (5,500 + 4,500) (1,100)
Gain 4,400

December
Disposal proceeds 4,800
Less: cost (part disposal) (£2,000 – 1,100) (900)
Gain 3,900

Total gains (£4,400 + £3,900) 8,300

Gain cannot exceed 5/3 × £(10,300 – 6,000) 7,167

Apportionment (based on proceeds)

May: £7,167 × (5,500/10,300) 3,827

December: £7,167 × (4,800/10,300) 3,340

Principles of Tax Solutions to interactive questions 157

Chapter 10
Solution: Capital allowances super-deduction
Year ended 31 March 2023
Super-deduction Main pool Allowances
£ £
TWDV b/f 250,000
Addition qualifying for super deduction:
£150,000 × 130% 195,000
Super-deduction (195,000) 195,000
Main pool addition – Honda 32,000
Disposal: machinery (22,000)
260,000
WDA @ 18% (46,800) 46,800

TWDV c/f 0 213,200

Total allowances 241,800

Solution: Capital allowances and long period of account

Capital allowances
Main pool Allowances
£ £
Chargeable accounting period
12 months to 31 March
TWDV b/f 24,000
WDA @ 18% (4,320) 4,320
TWDV c/f 19,680
Chargeable accounting period
3 months to 30 June
Disposal (3,000)
16,680
WDA @ 18% × 3/12 (751) 751
TWDV c/f 15,929

12 months 3 months
to 31 March to 30 June
£ £
Tax adjusted profits (12:3) 240,000 60,000
Less: capital allowances (4,320) (751)
Trading income 235,680 59,249

Solution: Property income

Rent accrued 1 January to 31 July
£24,000 × 7/12 £14,000
158 Solutions to interactive questions Principles of Tax

Solution: Chargeable gain for a company

Luggnag Ltd
£ £
Gross proceeds 140,000
Less: legal fees (6,000)
Net disposal consideration 134,000
Less: acquisition cost 100,000
legal fees 5,000 (105,000)
Chargeable gain 29,000

Solution: Non-trading loan relationships

K Ltd
Building society interest 5,000
Bank interest 2,000
Repayment interest on overpaid tax 50
7,050
Less: interest on loan repayment (3,250)
Non-trading loan relationship 3,800
Interest payable on loans to purchase plant and machinery used in a company’s trade is deductible against
trading income.

Solution: Corporation tax

T Ltd
£
Taxable total profits 1,300,000
£1,300,000 × 19% 247,000

Solution: Augmented profits

Z Ltd
£
Taxable total profits 500,000
Exempt ABGH distributions 10,000
Augmented profits 510,000

Solution: Impact of related 51% group companies on £1,500,000 limit

X Ltd

80%

Y Ltd

80%

Z Ltd
X Ltd owns more than 50% of Y Ltd, and indirectly owns more than 50% of Z Ltd (80% x 80% = 64%) so
both companies are related 51% group companies. The limit of £1,500,000 will be divided by 3 and
instalments will be due if augmented profits exceed £500,000. The limit of £20,000,000 will also be
divided by 3, and if the company is very large this will affect the dates instalments are due.
Principles of Tax Solutions to interactive questions 159

Solution: Payment by instalments

Accounting period starts 1 April 2022.
Instalments due 14 June 2022, 14 September 2022, 14 December 2022 and 14 March 2023.

Chapter 11
Solution: Historic test for registration
Caroline
Exempt supplies and supply of a capital asset of the business are not taken into account.
The taxable monthly supplies are therefore:
£
Standard rated supplies 7,560
Zero rated supplies 950
8,510

The threshold will therefore be exceeded after 10 months (£8,510 × 10 = £85,100) which is 30 April
2023.
Caroline must notify HMRC by 30 May 2023.
She will be registered from 1 June 2023.

Solution: Charge to VAT – standard rated supplies

J Ltd
VAT on VAT-exclusive supplies
£395 × 20% £79
VAT on VAT-inclusive supplies
£3,450 × 1/6 £575

Solution: Charge to VAT – reduced rated supplies

H Ltd
VAT on VAT exclusive supplies £500 × 5% = £25
VAT on VAT-inclusive supplies £1,260 × 5/105 = £60

Solution: Sale with discount

B Ltd
£
Value before discount 1,000
Less: discount (3% × £1,000) (30)
Value of supply 970

VAT charged (£970 × 20%) £194

Note that if the payment had not been made in the prompt payment period the full VAT of £200
would have been payable.
160 Solutions to interactive questions Principles of Tax

Solution: Fuel scale charge

Jethro
£437 × 1/6 £73

Chapter 12
Solution: VAT due
F Ltd
Output tax
£
Standard rate supplies (£134,285 × 20%) 26,857
Input tax
£
Purchases 37,750
Bad debt 1,500
Staff entertaining 14,464
53,714 (10,743)
× 20%
VAT payable (due electronically by 7 November) 16,114

Bad debt relief is available because the debt is more than six months old from the due date of payment.
Wages are outside the scope of VAT.
Input tax on UK customer entertaining is irrecoverable.

Solution: Tax point and accounting for VAT

Jason Ltd
Tax point is the basic tax point for order 1 (2 March), and the invoice date for order 2 (10 April) as it is
within 14 days of basic tax point (28 March) and before payment received (7 July).
The quarter ended 30 June only includes the VAT charged on order 2 as the quarter runs from 1 April
to 30 June. The VAT payable electronically on 7 August is £136.
Order 2
Tax point is 10 April
VAT @ 20% of £680 £136

Solution: Annual accounting scheme

W Ltd
Payments on account
1/10 × £12,800 £1,280

Due by 30 September (month 4 from the beginning of annual accounting period) and then at the end
of each month until the following 31 May (month 12)
Balancing payment
(£16,250 – [£1,280 × 9]) £4,730

Due by following 31 July (within 2 months of end of annual accounting period)

Principles of Tax Solutions to interactive questions 161

Solution: Flat rate scheme

Leon
VAT inclusive turnover
120 6
£25,200 × (or ) £30,240
100 5

VAT due £30,240 × 9% £2,722

Chapter 13
Solution: Self-assessment payments
Balancing payment required for 2021/22
£
Total income tax liability 18,400
Less tax deducted under PAYE (6,400)
Class 4 NICs 3,800
CGT liability 3,000
Less payments on account (15,000)
Balancing payment 3,800

Payments on account required for 2022/23

£
Total income tax liability 18,400
Less tax deducted under PAYE (6,400)
Class 4 NICs 3,800
21/22 tax paid under self -assessment 15,800

Hence, each payment on account will be £15,800/2 = £7,900

So, the payments Josiah will make are:
31 January 2023
 21/22 balancing payment of £3,800
 22/23 1st payment on account of £7,900
31 July 2023
 22/23 2nd payment on account of £7,900

Solution: Self-assessment penalties

Matt’s tax paid under self-assessment was £2,000 × 2 + £3,000 = £7,000
Matt filed his 2021/22 tax return 8 months late (it was due on 31 January 2023), hence his late filing
penalty will be £100 + 90 × £10 + 5% × £7,000 = £1,350
Matt paid his balancing payment 8 months late, so his penalty for late payment will be (5% + 5%) ×
£3,000 = £300
There is no penalty on the late 1st payment on account (but interest will be charged)

Solution: Corporation tax – late filing

The due date for the return was 30 June 2022, so Kay plc is 7 months late (filed 18-24m after
accounting period).
162 Solutions to interactive questions Principles of Tax

Hence, the penalty will be £200 + 10% of the tax due = £5,200

Solution: Late submission of VAT return

Joshua will receive his first penalty of £200 along with his 4th point, for the late filing of his return for the
quarter ended 31 December 2023. He will then receive another £200 penalty for the late filing of the
return for the quarter to 31 March 2024 (but will not receive another penalty point).
As Joshua has reached the penalty threshold (four points, filing quarterly), his points do not expire after
2 years. Instead, to be reset to zero he must satisfy both of the following conditions:
- he has submitted all his returns on time for the period of compliance (12 months as quarterly); and
- he has submitted all the VAT returns for the previous 24 months.
Joshua’s points will therefore reset to zero on the date on which the 31 March 2025 return is submitted
(ie by 7 May 2025).

Solution: Common penalty regime

The potential lost revenue (as the property income sits in Graham’s higher rate band) is £12,000 × 40%
= £4,800
Graham made a deliberate error but did not attempt to conceal it. His disclosure was prompted,
hence:
 The maximum penalty is 70% of the PLR = £4,800 × 70% = £3,360
 The minimum penalty is 35% of the PLR = £4,800 × 35% = £1,680
Principles of Tax Solutions to interactive questions 163
164 Solutions to interactive questions Principles of Tax

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