Adjustment of profits ― overview

Produced by Tolley
Adjustment of profits ― overview

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

  • Adjustment of profits ― overview
  • Why is the adjustment of profits relevant for tax?
  • What is GAAP?
  • The fundamental adjustments to profit
  • Statutory adjustments for specific items
  • Particular expenses which must be disallowed
  • Particular exceptions to the general rules regarding deductibility
  • Particular regimes requiring or allowing an adjustment
  • Common adjustments to profit
  • Items not taxed as trading income
  • More...

Why is the adjustment of profits relevant for tax?

Broadly speaking, profits generated by trading activities are subject to income tax in the hands of sole traders and partners, and corporation tax in the context of companies.

The tax legislation provides that the profits of a trade must be calculated in accordance with generally accepted accounting practice (GAAP), subject to any adjustments required or authorised by law. The starting point for calculating trading profits is usually the profit before tax figure as per the accounts, which is then subject to tax adjustments where applicable, which ultimately leads to the amount of total taxable profits.

See Simon’s Taxes B2.101.

What is GAAP?

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

  1. UK GAAP (for most trades this will be either FRS 102 or FRS 105 for micro entities), see FRC: UK Accounting standards

  2. International Financial Reporting Standards (IFRS) and any International Accounting Standards (IAS) that have not been superseded by IFRS

Since the above choices all fall within the GAAP umbrella for UK tax purposes, as long as the basis of choice is applied in full when preparing the accounts of a company, HMRC must accept that as a valid basis. HMRC cannot insist on another basis which gives a higher taxable profit, nor can it deny a basis which gives a lower taxable profit than another.

HMRC guidance on the accounting principles relevant to the computation of trading profits can be found in BIM31000–BIM31115. See also Simon’s Taxes B2.102.

The fundamental adjustments to profit

Once the profit before tax has been calculated using GAAP, it must be adjusted for tax purposes. The adjustments required under tax law range in their application from the highly specific to the very broad.

The two most fundamental adjustments which have very broad application are as follows:

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