B2.101A How are trading profits and losses calculated for tax purposes?
Income tax is charged on the full amount of profits generated by the trade in the tax year. Guidance on the way in which such profits should be calculated has evolved through the courts over time, which has subsequently been incorporated into statute.
ITTOIA 2005, s 25(1) provides that the profits of a trade must be calculated in accordance with generally accepted accounting practice (see B2.102), subject to any adjustment 'required or authorised by law in calculating profits for income tax purposes'. This is unless the cash basis of accounting is being used, see B2.112–B2.112A.
An alternative basis of calculating trade profits was also available for barristers and advocates, which may still apply under transitional rules (see B5.610), and section 25 continues to be subject to specific rules relating to the calculation of profits of Lloyd's underwriters (see Division E5.6)1.
Adjustment of profits
In all but the simplest cases, the profit (or loss) shown in the profit and loss account must be adjusted to arrive at the trading profit for income tax and corporation tax purposes. Some of these adjustments increase the stated profit (or reduce the loss) while others reduce the profit (and increase the loss).
The Tax Acts contain some provisions allowing or prohibiting certain deductions. The adjustments set out in the tax legislation are supplemented by a body of case law, which are described in detail in Divisions B2.3 and B2.4. Different rules apply if profits are calculated on the