New trading allowance: simplicity, but not as we know it

Two new £1,000 tax-free allowances are available from 6 April 2017 – the property allowance and the trading allowance[1]. This article looks at the trading allowance only – the property allowance will be addressed in a future article.

Read about the property allowance here. 

The aim of the trading allowance is to provide simplicity and certainty regarding income tax obligations on small amounts of trading and miscellaneous income from providing goods, services or other assets.

Although the concept of a £1,000 tax-free allowance sounds very simple, there are a number of complexities of which taxpayers and advisers need to be aware.

Full exemption: keep an eye on income, not profits

At its simplest form, the trading allowance provides for a complete exemption from income tax if total trading and miscellaneous income in the year is less than £1,000.

Not only is there no income tax to pay, but also no need to register with HMRC or file tax returns provided trading income is below this level.

It should be noted the £1,000 threshold applies to income, not profits and there are some complications and exceptions to be aware of (as set out below).

Individuals who qualify for full exemption will need to monitor their income levels year-on-year: if their income goes above £1,000 they will be subject to self-assessment.

Partial exemption: is it the right choice?

Where trading income exceeds £1,000, the legislation allows for so called partial relief. Effectively, individuals can choose to either:

• Deduct their actual business expenses from trading income in the usual way, or
• Elect instead for the £1,000 trading allowance as a deduction from income.

It should be noted that if you claim partial relief you cannot deduct any other expenses, just the £1,000 allowance.

Individuals can decide on a year-by-year basis which approach to take. This will depend on the type of business and the level of expenses incurred that year. For example:

• Businesses with recurring outgoings (e.g. purchase of stock) are likely to be better off claiming actual expenses.
• Small services businesses with minimal overheads and costs (e.g. a self-employed tutor) are likely to find the trading allowance more beneficial unless they have a one-off large revenue expense in any year.

Cash basis or GAAP?

The trading allowance applies equally to both cash basis and GAAP accounting scenarios – the £1,000 threshold is simply applied to whichever measure of income/profits you adopt.

There is one exception to this. For the purposes of full relief (only), if:

• your GAAP income would be more than £1,000,
• but your cash basis income would be less than £1,000,

then the cash basis is assumed to be used rather than GAAP. In effect, this allows full relief without requiring a cash basis election to be made. If the taxpayer really wishes GAAP to apply, they can elect out of full relief.

Exclusions

The trading allowance rules include some exclusions to be aware of, in particular:

• The trading allowance cannot be claimed for partnership trades, or for income which attracts rent a room relief.
• No relief is available if an individual’s trading income includes any amounts received from:
  • an employer, or a spouse / civil partner’s employer.
  • a partnership in which they (or a connected party) are a partner; or
  • a close company in which they (or an associate) are a participator.

The first of these exclusions is particularly restrictive – any amount of such income will completely deny relief for the year. For example, if you are employed and have a sideline in selling photographs of old buildings, the sale of one photograph to your employer (or your spouse’s employer) will prevent you from claiming the trading allowance, even if you sell hundreds of photos to other unconnected parties.

Second trades

For the purposes of the trading allowance, the income and profits of all an individual’s trades are combined. This can lead to difficulties if an individual with an existing sole-trade business starts a smaller second trade.

For example, if a self-employed window cleaner starts up a small business of giving violin lessons:

• Full relief will not be available for the new trade (assuming their combined income from both trades exceeds £1,000).
• Partial relief is likely to be economically unattractive, as they would not be able to claim for the expenses incurred in their window cleaning trade.

This results in an unequal situation whereby an individual can receive unlimited income from employment or a partnership and still claim the trading allowance, but an existing sole-trader is unlikely to benefit from the allowance.

This point has been raised with HMRC by the ATT, but at the time of publication this remains the position under the trading allowance legislation.

Emma Rawson is an ATT Technical Officer.

[1] The allowance was originally announced at Budget 2016 and was one of the many measures dropped from the Finance Act 2017 due to insufficient time for debate. It has now been reintroduced as part of Finance (No. 2) Bill 2017, published in September 2017. This article is based on the legislation set out in that Finance Bill as at 1 October 2017.