Advanced Taxation and Self-Employment - Case Study Example

ASSIGNMENT Name: Course: Instructor: Institution: City: Date Self-Employment An individual like Henry runs his own business and therefore he is the employer and the employee. Henry engages in an income generating activities therefore his income must be subject to self-employment tax. Medicare and social security is not captured in the paychecks of the self-employed, therefore self-employment tax is designed to capture all these (Allan, 2016). 31 Dec 2015 profit £24,000 £ 28500 31 Dec 2016 loss £ 9 100 £ 6400 The adjusted trading profit at the end of December 2015 after the deduction of capital allowances is £ 24,000 The tax year of the business commences the first year the trading profits are taxed (Allan, 2016). The basis period in the first year of taxation is usually less than 12 months; however, the following taxation years are always 12 months (Allan, 2016). The basis period for a tax year in self-employment is the accounting year ending in that tax year. For Henry, the accounting year to December 31 2015 ends during 2015-2016 thus forming the basis period for 2015-2016 (Allan, 2016). Therefore, the business’s profit of the year to 31 December 2015 is charged to the income tax for the 2015-2016 tax years. The basis period for Henry is outlined in the table below: 2014-2015 Actual 1 January 2015 to 5 April 2015 2015-2016 12 months to accounting date in year 2 Year to 31 December 2015 2016-2017 Current Year Base Year to 31 December 2016 Tax relief In a case, a person doing personal business incurs losses the income is set to nil; therefore, Henry’s loss of £ 9,100 will be set to nil for the tax year 2016-2017. Henry may also claim tax relief in respect to the loss incurred. There are various forms of tax relief, which may help a businessperson like Henry to offset his losses. Theses relief are known as relief for trading losses and they include carry forward trade loss, trade loss relief against total income, early trade losses relief and terminal trade loss relief (Allan, 2016). Carry-forward Trade Loss Relief Under section 83 of ITA 2007, a trading loss is carried forward and will be relieved against future trading incomes that may arise from the business. The relief only relieves the trading income and not any other income (Allan, 2016). The amount of tax relief for every year must not exceed the trading profit for the same year. The relief on future trading income is provided if it results from the same activities that made an individual like Henry incur the losses. Capital Allowances Capital allowances claimed during the period of business operation are usually treated as trading expenses incurred during the period. When calculating trading loss these capital allowances are automatically included (Allan, 2016, 2015, 2014). Therefore, it is right to state that Henry’s trading loss is inclusive of the capital allowances. It is not necessary to claim maximum capital allowance available for a given accounting period. Henry can claim less than the maximum amount of capital allowance or even fail to claim in order not to waste his personal allowances when relieving trading loss (Allan, 2016, 2015, 2014). Disclaimed personal allowances can be claimed at a future date since they cannot be lost permanently. This result in higher written down values being carried forward hence makes it possible to have large amounts of capital allowances at a future date (Allan, 2016, 2015, 2014). . Before capital allowance (£) Capital allowance (£) After capital Allowance (£) Year to 31 December 2016 (6,400) (3,000) (9,400) The trading losses that Henry will carry forward will be £9400 inclusive of the capital allowance. Based on his future profits, Henry will be able to determine whether to claim all of his capital allowance (Allan, 2016, 2015, 2014). Analysis of the effect of capital allowance on the future profit will help in making a sound decision. However, carry forward trade loss relief as a form of loss relief has some shortcomings, which include, Wastage of personal allowances since the business owner lacks control over the amount of relief provided every taxation year. Relief may be provided at a lower rate especially at the time when the tax rate is falling. This may be disadvantageous to the a trader especially when the rates that were in place when loss was incurred were hire as compared to the current rate. Delaying of the loss until a trader realizes profit at a future date from the same trade that incurred the loss; however, this may not favor a trader since the business might not incur profit. It is important for Henry to consider another option that may help solve these problems, for instance the use of trade loss relief against trade income. Trade Loss Relief against Total Income Section 64 of ITA 2007 provides an alternative loss relief form that helps in overcoming some of problems associated with carry forward trade loss relief (Allan, 2016). Trade loss relief against total income makes it possible to offset trade losses against the total income for a period of two years (Allan, 2016). According to Allan, (2016) applying trade loss relief against total income Henry must take note of the following important issues, He is not obligated to make claims that enables him to set trading losses against total income. Unrelieved losses remaining after claim has been made to set the trading losses against total income must be brought forward automatically. Trading loss can only be applied when the business being carried out is on commercial basis with the main aim of making profit. Relieving a Trading Loss against Total Income According to section 64 of ITA 2007, relieving a trading loss against total income can be applied when a trader incur trading losses in a tax year (Tilay, 2014). The amount of trading loss in this scenario is that loss incurred during the basis period of the tax year. A trading loss incurred during a taxation year can be set against a total income of either, the previous tax year, tax year in which the loss is incurred or when the loss is large both years may be used (Kay, 2014). If Henry wishes to set his trading loss against total income, he must make the claim by 31 January 2019, which is two years after the loss was incurred. National Insurance National insurance contributions must be paid by the self-employed just like the employers and employees. Self-employed people pay the class 2 of national insurance contributions (Allan, 2016) For the year ended 31 December 2016, Henry incurred a loss of £9400, a clear indication that his earnings were too low to make national insurance contributions for that year. However, according to Class 3 national insurance contribution henry can make voluntary contribution to ensure he maintains full contribution record (Allan, 2016). Furthermore self-employed people who are below the pensionable age and above 16 years are liable to pay class 4 national insurance contributions. Class 4 national insurance contribution for a person who is self-employed is calculated based on the amount of trading income charged to income tax for that particular year. The class 4 liability is based on the trading income of the tax year after adjusting the capital allowance and trading losses before deductions of pension contributions (Allan, 2016). In case of Henry for the taxation year ended 31 December 2015, he will make class 4 national insurance contributions as follows: 9 %( 28500-8060) = £1839.60 However, for the tax year ended 31 December 2016, Henry would not make national insurance contribution since he made a loss, an amount that is far below the profit limit for contribution. Therefore, his contribution was nil (Allan, 2016). Principal Private Residence Private residence refers to an individual’s main residence (James, 2010). According to the case, Yasmin was main residence of the house since 1984 up to the date when she recently sold the house. Principal Private Residence is usually not chargeable for capital gain tax; however, capital gain tax liability may arise when the property disposed of was partly used for other activities and partly as a residence (Allan, 2016). Private residence may be subjected to capital gain tax liability when its owner during the period of ownership was not its main residence. During the period when Yasmin was absent from the, she was considered main residence. Purchase price $120,000 (1984) Selling price $975 000 Calculation of chargeable gain Capital gain tax (CGT) Principal Private Residence is usually not chargeable for capital gain tax; however, capital gain tax liability may arise when the property disposed of was partly used for other activities and partly as a residence (Allan, 2016). Private residence may be subjected to capital gain tax liability when its owner during the period of ownership was not its main residence. Yasmin shah is therefore liable to CGT since before disposal of the house he used part of the house as a business and he rented it during his stay in USA. The gain that accrues from the disposal of Yasmin’s house is chargeable to tax (Allan, 2016). For Yasmin to be liable to capital gain tax she must be deemed a residence of the house. Deemed Residence Yasmin is deemed to be a residence of the house since the time she bought it up to the time she sold it, even during the period she let the house or during the she was at her mother’s apartment (Chittenden, Foster, &, Sloan, 2010). The period of deemed residence during the period of ownership of the house include: During the period when the taxpayer is working abroad When the four years absence limit is not exceeded during the period when taxpayer is working within any town in the United Kingdom. Yasmin’s period of ownership of the house can be broken down into the following periods No. Period Period (months) Nature of residence i. 1984 to 1990’s Actual residence ii. 1990’s Working in USA/ house let to tenants iii. June 2000 to July 2004 48 months Living at her mother’s residence iv. January 2008 to January 2013 60 months One room in the house used an office for her business In period (i) and (iii) above, Yasmin is exempted from CGT since she was an actual residence. Period (iii) when Yasmin was living with her mother is an exempt since she used to reside in the property before and the four-year stay at her mother’s residence was within the exemption limit (Allan, 2016, 2015, 2014). During period (ii), Yasmin let her house to tenant when she went to work in USA. Yasmin during this period is liable to CGT since she derived income from the property. However, the gains from the tenants will be subjected to letting relief (Allan, 2016, 2015, 2014). In period (iv) when Yasmin used part of the house as an office for her own business, she is liable to Capital gain tax since this is an income generating activity. The last 36 months of the ownership period is always an exempt of capital gain tax (Allan, 2016, 2015, 2014). . £ Sale Proceeds 975,000 Less: Acquisition cost 120,000 Chargeable gain before PPR exemption 855,000 Less PPR Exemption 288/396 * 855000 (621,818) Chargeable gain 233,182 Annual exempt amount (11,000) 222,182 Capital gain tax 10% * 222182 22,218.20 Letting Relief Letting relief is an extension of principal private residence exemption that arise when property is let to tenant for residential accommodation (Allan, 2016). IA chargeable gain will arise to Yasmin since during the period of his absence he let his residence to tenants thus generating rent income. Yasmin let her house to tenant when she went to work in USA. During this period she is liable to CGT since she derived income from the property. However, this chargeable gain will be subject to letting relief. However, the relief will be reduced since the house was not fully for dwelling but also meant for office business. The annual rent a house relief is £7500 Business purpose The gain attributable to the part of the house where the business office was located is liable to capital gain tax (Allan, 2016). This gain is not subjected to any form of relief(Allan, 2016. During the period when Yasmin used part of the house as an office for her own business, she is liable to Capital gain tax since this is an income generating activity (Allan, 2016). This is an indication that she used the house partly for residence and partly for business. Therefore, the part of the house that was used for residence shoud be exempted from capital gain tax whereas the part meant for business will attract capital gain (Allan, 2016). The part of the house used for business office is not subject to exemption for the last 36 months of ownership. £ Sale Proceeds 975,000 Less: Acquisition cost 120,000 Chargeable gain before PPR exemption 855,000 Less PPR Exemption 288/396 * 855000 (621,818) Chargeable gain 233,182 Reference ASSOCIATION FISCALE INTERNATIONALE, & LUPO, A. (2012). Tax systems of UK and Italy, a comparative analysis: International fiscal association, bilateral meeting of the UK and Italian branches, Florence 2009. Milano, EGEA. CHITTENDEN, F., FOSTER, H., & SLOAN, B. (2010). Taxation and red tape: the cost to British business of complying with the UK tax system. London, Institute of Economic Affairs. JAMES, M. (2013). The UK tax system: an introduction. London, Spiramus. KAY, J. A., & KING, M. A. (2014). The British tax system. Oxford [Oxfordshire], Oxford University Press. LYMER, A. (2012). Taxation. Birmingham, Fiscal. MELVILLE, A. (2014). Taxation: Finance act 2014. MELVILLE, A. (2015). Taxation: Finance Act 2015. http://www.myilibrary.com?id=887079. TAXATION Finance Act 2016, Allan Melville, Pearson "available at http://catalogue.pearsoned.co.uk/educator/product/Taxation-Finance-Act 2016/9781292139104.page" TILEY, J., & LOUTZENHISER, G. (2014). Revenue Law: Introduction to UK Tax Law; Income Tax; Capital Gains Tax; Inheritance Tax. https://nls.ldls.org.uk/welcome.html?ark:/81055/vdc_100034739792.0x000001. Read More