Assessable trading income refers to the portion of a business’s trading profits that is subject to taxation. It is a critical concept in tax accounting, as it determines how much income a business must report and pay taxes on. The calculation of assessable trading income involves identifying total trading income and making appropriate adjustments for tax purposes, such as disallowable expenses and capital allowances.
1. Understanding Assessable Trading Income
Trading income is generally derived from the activities of buying and selling goods or services. For tax purposes, not all income and expenses shown in the financial statements are allowable, so adjustments must be made to arrive at assessable trading income.
A. Key Features
- Basis of Assessment: Usually based on profits calculated under accounting principles and adjusted for tax rules.
- Tax Reporting: Businesses must report this figure to the tax authority on their tax returns.
- Applicability: Relevant for sole traders, partnerships, and incorporated businesses.
2. Components of Trading Income
Trading income includes all income derived from the main business activities, and sometimes other related income.
- Sales Revenue: Gross income from the sale of goods or services.
- Other Operating Income: May include commissions, service fees, or discounts received.
- Income from Business Assets: Income derived from the use of business-owned equipment or property.
3. Adjustments to Accounting Profit
To determine assessable trading income, the business’s accounting profit must be adjusted to comply with tax rules.
A. Add Back Disallowable Expenses
- Examples: Entertaining clients, fines and penalties, depreciation (replaced by capital allowances), non-business expenses.
B. Deduct Allowable Non-Accounting Items
- Capital Allowances: Tax relief on capital expenditures such as plant and machinery.
- Loss Reliefs: Losses brought forward or carried back that are allowable for tax purposes.
C. Include Taxable Income Not in Accounts
- Example: Profits from unrecorded sales or recoveries of previously written-off debts.
4. Formula for Assessable Trading Income
Assessable Trading Income = Accounting Profit
+ Disallowable Expenses
− Allowable Deductions (e.g., capital allowances, losses)
+ Taxable Income Not Included in Accounts
5. Example Calculation
Given:
- Accounting Profit: $120,000
- Disallowable Expenses: $10,000 (e.g., entertainment)
- Capital Allowances: $8,000
- Taxable income not in accounts: $2,000
Assessable Trading Income = 120,000 + 10,000 − 8,000 + 2,000 = $124,000
6. Timing and Basis of Assessment
A. Accruals Basis
- Income is assessed when earned, not when received.
- Expenses are deducted when incurred, not when paid.
B. Cash Basis (For Small Businesses)
- Income is assessed when received.
- Simplified method available for sole traders and partnerships with turnover under a threshold.
7. Common Errors in Determining Assessable Trading Income
- Failure to add back disallowable expenses.
- Incorrect application of capital allowances.
- Omitting taxable income from accounts.
- Misclassifying personal expenses as business expenses.
Tax Planning and Compliance Considerations
Correctly calculating assessable trading income ensures compliance with tax laws and minimizes the risk of penalties. Regular reviews, maintaining detailed records, and working with qualified tax professionals can help businesses manage their tax obligations efficiently and reduce tax liabilities through legitimate reliefs.