Income Tax of a Small Business - Coursework Example

Finance and Accounting: Income Tax Word Count: 2,021 (8 pages) SCENARIO 
 Ronni, aged 35, owns and runs a small business from a shop in Southwark, selling new and second hand bicycles and a range of cycling accessories. Her customers include commuters, as well as local cycling enthusiasts and children. The business has prepared financial statements for the year ended 30 September 2011 and relevant information is given below. 

 The Income Statement showed the business made a net profit in excess of £30,000 after taking into account the following information: 

 1. Ronni received additional income from investments and property which was included in the Income Statement as shown below: 
Building society income received £5000 
Rent received from rental of flat above shop, net of allowable expenses £5000 2. Wages and salaries was composed of: 
Salary taken by Ronni, £25,000 
Wages paid to Bryn (Ronni’s father) for work done to repair bicycles, at a rate of £20 per hour (30 hrs x 48 weeks) = £28,800 
Wages paid to assistant bicycle repairer at a rate of £15 per hour (30 hrs x 48 weeks) = £21,600 
Casual help in shop, £5,400 

 3. Rent and rates was composed of: Business rates for shop and workshop £2,500 
Rent of warehouse space £5,200 
Council tax for Ronni’s flat £920 


 4. Repairs and renewals was composed of: 
Repairs to warehouse floor £850 
Repairs to flat above shop £750 
Cleaning materials £300 
Cleaning contract for shop and workshop 
£500 
Sundry small items £250 



 5. Motor Expenses mainly for the cost of running Ronni’s estate car used for collecting/delivering broken/mended bicycles and for transporting items for the shop from the cash and carry outlet. Private use of the car had been agreed at 30%. 
Diesel fuel, car £8500 
Insurance for car £1200 
Repairs, car £350 
Road fund tax, car £375 
Rental of van £600 

 6. Light and Heat was composed of: 
 
Electricity – shop and warehouse £720 
Electricity – flat above shop £450
Gas – Ronni’s flat £380 

 7. Sundry expenses of were composed of: 
Subscription to magazine, ‘Cycling Today’ 
£100 
Subscription to Green party £50 
Subscription to ‘New Transport Systems’ 
£24 
Sponsorship of local junior school cycling proficiency awards £50 
Donation to Green party £25 
Donation to local hospital A&E department (Ronni had an accident and broke her arm) £100 

Postage, stationery and telephone expenses £100 

Accountancy charges £80 
Sundry other items £100

 8. Depreciation was calculated on a reducing balance method and amounted to £5,800 

 9. Ronni sold a car on 1 March 2011 and the loss on sale was included in the accounts as £950 

 10. The value of written down values for capital allowances as at 1 October 2010 were: 
 £ 
Main pool 4,000 
 Ford Focus car, emissions 190g/km, 30% agreed private use 
 £2,000 

 Proceeds of 15 Oct. 2010 Ford transit van, cost £3,000 1 March 2011 Ford Focus car, 30% agreed private use, cost £6,000 

 1 June 2011 Work bench, cost £1,500 1 March 2011 Peugeot 407 estate car, emissions 180g/km, 
30% agreed private use, cost £20,000 1 May 2011 Work bench and other tools £1,400 
 30 Sept 2011 Ford transit van £13,000 


 TASK 1 Calculate the taxable trading profit for Ronni’s business for the year ended 30 September 2011. 
You should provide your own data where none is given, ensuring that you retain a taxable trading profit (i.e. not a trading loss) and should ensure that you choose data that will fully demonstrate your knowledge of taxation. The total income was £90,800. The total expenses for the business were deemed to be £66,317. Therefore the taxable trading profit for Ronni’s business was £24,483.

 TASK 2 
 Calculate the Income tax payable by Ronni for the tax year 2011/12, providing your own data where none is given, to fully demonstrate your knowledge of income tax. 

Ronni received additional income during the year, comprising: 
ISA interest, £400 
Premium bond winnings of £10,000 
Dividends of £8,000 from shares valued at £100,000 
Part-time earnings as cycle race official, £6,000. Additional income added onto the taxable trading profit would be £124,000. Plus £24,483, this equals £148,483.

 TASK 3 Ronni has asked you for answers to questions as she is keen to reduce her income tax payments. 
Your answer should take the form of a letter to Ronni, who is a client of the firm you are employed by. 

1) If Bryn’s salary was increased to £40 per hour (hours unchanged), would this reduce the profit of the business and the income tax payable? 

 2) If all the expenses of Ronni’s flat were included in the business expenses, would this reduce the income tax payable? 

 3) What is the point of including a salary for the owner of the business, when not all of it is taken from the business and the hours worked by the owner are far in excess of those of a ‘normal’ employee. 
Ronni has calculated that she spends 10 hours per day, 6 days per week in the shop and another 10 hours per week on record keeping, stock-taking, marketing and buying stock. 

 4) Do you have any advice to enable Ronni to reduce her income tax liability? 

 Dear Ronni, Giving Bryn more dollars per hour would only increase the profits of the business and would make the income tax payable more, to address the first question. If all the expenses of your flat were included in the business expenses, that would make the income tax less payable (that’s how it was calculated). The point of including a salary for the owner of the business is to know how much you are paid so you can take any necessary tax breaks off of your salary for having run the business. The only advice that I would give to you, in terms of what would help you reduce your income tax liability, is to have all the workers become independent contractors, and you can also make sure that you aren’t charging people by hours of works it takes but of money due on a per-project basis. Let’s take an example. If a bike takes 8 hours’ worth of work, and Bryn fixes the bike for £280, what might more accurately reflect the project’s price is £350 or £400. Thus, your business could still skim a little off the top and have some left over for taxes. Thus, work should be done on a per-project estimate, and then after that you will have less tax liability. Sincerely, Your Accountant TASK 4 The following measures were proposed in the 2011 Budget: Explain and comment on the changes proposed for the items listed in a) to d) below. a) Charities will be able to claim gift aid for a donation without a gift aid declaration Charities should not be able to claim gift aid for a donation without a gift aid declaration. Otherwise, if the charity were to be audited, there could be huge problems! Charities are just like businesses in the sense that they have to report what kind of donations they get from the public. People cannot just donate in any old way. They must have a gift aid declaration and a receipt should be held by both parties. b) Restriction of tax relief for employer-supported child care 
 This would be a bad policy to implement because parents should not be penalized financially for having had children. They should be given tax relief for employer-supported child care. If anyone, parents should get a tax break! c) The creation of new enterprise zones The creation of new enterprise zones might be smart, because then Ronni might be able to get more tax breaks on her business. For example, they might expand their building, get new equipment, and/or hire new and more employees. It is recommended that Ronni make full advantage of her tax lawyers, who specialize in these kinds of legal dilemas. She should definitely consider asking for her lawyers to find some kind of tax loopholes, realizing that this will give Ronni significant tax breaks or a tax-free business. There was one multimillion dollar corporation in the U.S. (GE) which did not have to even pay taxes! This was probably because they had a lot of business expenses written off. d) Proposed changes to the taxation of non-domiciled individuals It must be noted that a fee simple is the closest thing to absolute ownership that one in a business can have, however it does not mean that one necessarily completely owns the property. This may be difficult to understand, but basically it is a guarantor that someone cannot just blatantly take over someone else’s property if there are encumbrances upon the piece of land being sold, similar to liens in other countries. Non-domiciled individuals may have difficult with proposed changes to the taxation law. They may not have lawyers; that notwithstanding, they may also have other difficulties that impinge on the profits they make from the business as well. It’s important for the employer, Ronni, to realize that she is helping her business by keeping costs low. Because, as incomes rise, so do the prices of everything from labor to equipment to materials and so forth. It behooves Ronni to try to cut overhead as much as possible in order to salvage her business. After all, she is in business to make money, not lose money. It makes sense that she try her best to absorb as many costs as she can without having to report them if they’re something that will not be able to be deducted off the taxes, either as an expense or a business loss. Ronni should try her best to ensure that she gets a good lawyer who can analyze the possible loopholes that could apply to her situation. As long as Ronni continues to pay her taxes like she should, she shouldn’t have any problems. The real problems for businesses begin when they either: a) get too big to manage; or b) need extra capital for the business. In the case of option A, Ronni would have to hire more people in order to take care of the overwhelming demand for more staffing. Option B would require Ronni to take out loans or find some financial means of supporting her business if she needed capital—let’s say, to expand, for example. These kinds of issues plague business owners all the time, but if she were able to somehow maneuver that problem, she might very well be able to continue having a burgeoning business where she has taken over 100% of the market for her niche market in the bicycle business. One detractor that could prove problematic would be if another store tried to take away her business, and might be more attractive since it is newer and has better advertising. So, Ronni should definitely look into advertising costs and deduct them from her business expenses, as a sort of insurance for the future that would help her stay competitive. Without a doubt, Ronni has a good business going, and she should try to keep that business by churning out excellent products and doing the best she can, encouraging her staff to keep doing great work. Because, ultimately, that is what a business is known for—doing excellent work. Since Ronni seems to have great control over learning how to track business expenses, it’s important that Ronni also demonstrate evidence of satisfied customers in her shop, which will enhance her brand even more. These were just a few ideas in order to spur on the growth of Ronni’s huge investment in her bicycle business. It only makes sense that she should ensure that her business remains vital and important in an age when people want superior customer service and a great end-result or finished product. APPENDIX All amounts are in pounds. INCOME (+) 5000 5000 25000 28800 21600 5400 TOTAL: 90,800 EXPENSES (-) 2500 5200 920 850 750 300 500 250 (.70) (11025) = 7718 720 450 380 100 50 24 50 25 100 100 100 80 5800 950 4000 3000 4200 1500 14000 1400 13000 TOTAL: 66,317 INCOME – EXPENSES = 24,483 BIBLIOGRAPHY Law FCT v French (1957) AITR 76. Section 6-5 ITAA 97. Section 15-2 ITAA 97. Section 21A ITAA 36. Kelly v FC of T 85 ATC 4283. Stone v FCT 2005 ATC 4234. Tagget v FC of T 2010 ATC ¶20-210 Taxation Ruling TR 1999/17. Read More