Thinking of starting a new business on the side? How can the trading allowance help you? This article will introduce you to it and how it works.
The trading allowance was introduced from 2017-18 onwards. The allowance is £1,000 and can be used in two different ways. If after the pandemic you are thinking of trying a new side business, it could be very beneficial in reducing reporting requirements while you start out or reducing taxable profits. The following examples illustrate when the allowance could be used and how it is beneficial.
Example 1:
Let’s say Jon works part time and would like to use his spare time to start his own business. He decides the best way is to sell through an online marketplace, I’ll leave you to decide what he will sell. Jon’s only costs to get started are a few materials of £50, his ongoing costs will be any commission and fees charged by the marketplace. Suppose Jon made sales of £900. Minus his materials of £50 and we will assume commission and fees of £90, he has made a profit of £760.
How will Jon use the allowance?
It is important to remember the allowance is applied to sales rather than profit. In this case as Jon’s sales are £900, he could use the trading allowance to exempt the income from tax and as a result would have no reporting requirements and no additional tax to pay. This would be the best result as Jon’s only other income is employment and his tax and national insurance will be dealt with by his employer through PAYE.
There is another way the allowance can be used. Take for example Jill.
Example 2:
Jill also works part time and like Jon wants to start her own business. She also decides an online marketplace is the way to go. Her results are better than Jon’s! Jill makes sales of £1,500. Her materials to get started were £75 and commissions and fees are £150. She has made a profit of £1,275.
How will Jill use the trading allowance?
As her sales are over £1,000, she can’t use it in the same way as Jon to exempt the income all together. Her part time income is over the tax-free allowance for the year so any other income will be taxable. If she choses to calculate her profits under normal trading income principles the profit would be £1,275. Tax on this would be £255.
An alternative for Jill is to claim a deduction of the trading allowance. This is done in place of claiming expenses. In this case she would have a taxable profit of £500 (£1,500 sales less the £1,000 trading allowance). Tax on this would be £100, a much better result for Jill and all her hard work.
I hope you have enjoyed this introduction to the trading allowance. As with all tax situations an overall view can be helpful but claims and elections should be made on a case by case basis having carefully considered the circumstances. For example, if a loss is made under normal trading income principles it could be beneficial to preserve the loss for future benefit. There are also rules to avoid the abuse of the trading allowance when connected parties are involved so do take care and take advice in these areas.
If you would like to discuss the trading allowance and review if it would benefit you please feel free to contact me and discuss the services I can provide.
