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HMRC internal manual

Business Income Manual

Trade profits: what is chargeable?

S25(1) Income (Trading and Other Income) Act 2005 (ITTOIA 2005); S46(1) Corporation Tax Act 2009 (CTA 2009)

Income Tax is charged on the ‘profits of a trade’ and in S7 ITTOIA 2005 this is amplified by the direction to charge ‘the full amount of the profits of the tax year’. The guidance in the Taxes Acts on the way these profits should be calculated is not comprehensive and the methodology has emerged and been refined over many years through Court decisions. Many of the principles established by the Courts have subsequently been incorporated into the Statute.

The important words in Section 7 are ‘the full amount of the profits’. They have been interpreted by the Courts as requiring the consideration of ‘profits’ as that word would be understood in its ordinary sense in commercial life. This involves setting against the receipts of a trade etc in any given period the expenses incurred to earn those receipts.

The approach, in summary, is a two stage process as follows:

  1. Ascertain the profits of the trade for the period computed in accordance with generally accepted accounting practice.
  2. Adjust the accountancy profits in accordance with any tax rules or principles which differ from generally accepted accounting practice.

In essence, therefore, if there are no relevant tax rules or principles which affect a particular case, generally accepted accounting practice will determine the amount of the taxable profit for the period.

This approach is made statutory by S25(1) ITTOIA 2005 which provides that the profits of a trade must be calculated in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law in calculating profits for income tax purposes.

From April 2013, S25A ITTOIA 2005 provides that certain eligible businesses may calculate the profits of their trade on the cash basis instead of in accordance with generally accepted accounting practice (see BIM70000 onwards).The Corporation Tax charge is also on the ‘profits of a trade’ but there is no reference in the statute to ‘the full amount of the profits’. Nevertheless the same approach to calculating the profits applies as for Income Tax. The equivalent statute is S46(1) CTA 2009. There are however particular differences in the treatment of specific items, such as the special Corporation Tax regimes applying to loan relationships and foreign exchange (FOREX), derivative contracts and intangible assets. For details on where to find further guidance on these regimes see BIM00510.

You will find further guidance as follows:

Statute law BIM15045 onwards.

General rules on measuring profits BIM30000 onwards.

Accountancy principles BIM31000 onwards.

Specific adjustments BIM40000 onwards.

Computing the amount to be assessed BIM80000 onwards.