General principles ― sole traders and partnerships

By Tolley

The following Owner-Managed Businesses guidance note by Tolley provides comprehensive and up to date tax information covering:

  • General principles ― sole traders and partnerships
  • Statutory rules for tax adjustments to profits
  • Capital expenditure
  • Wholly and exclusively
  • Statutory adjustments to specific income / expenditure
  • Transfer pricing
  • Trading income provided through third parties
  • Profit fragmentation
  • Approach to calculating taxable profits
  • Small businesses

This guidance note looks at how trading profits of sole traders and partnerships are calculated for income tax purposes. Additional special rules apply for very small businesses, as detailed below.

Statutory rules for tax adjustments to profits

The basic rules determining the calculation of trade profits and losses for income tax purposes are found in ITTOIA 2005.

The rules are derived from ICTA 1988, which also provided the basis of the rules now found in CTA 2009 for companies. Consequently, many of the general principles share a common basis in law. Where there is a common statutory basis, case law is equally applicable between income tax and corporation tax. For example, the principles established in Law Shipping v IRC are applicable to unincorporated businesses even though the case concerned a limited company.

Law Shipping v IRC [1923] 12 TC 621 (subscription sensitive)

The most general rule applicable to calculating profits in relation to income tax is that, in the absence of any amendment required for tax purposes, the trading profit or loss is calculated in accordance with generally accepted accounting procedures (GAAP).

ITTOIA 2005, ss 25–27

This means that the profit before tax (PBT) is the starting point of the tax calculation. This is then subject to adjustments required by tax law.

What is GAAP?

GAAP is defined for this purpose by CTA 2010, s 1127. GAAP currently includes accounts prepared under:

  • UK GAAP (for most businesses this will be either FRS 102 for non-micro entities or FRS 105 for micro entities), see FRC: UK Accounting standards 
  • International Financial Reporting Standards (IFRS) and any International Accounting Standards (IAS) that have not been superseded by IFRS

HMRC guidance on

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