Q&A: How trading allowance tax exemption works

Q: My client has been reading about a new tax exemption called the trading allowance. What is this and how does it work? For example, is the new trading allowance of £1,000 in relation to gross receipts or the profit amount? 

A: The Finance Act (No. 2) 2017 introduced £1,000 trading allowance and £1,000 rental allowance from 6 April 2017. To answer the question, I will focus on trading allowance. It means that:

  • Individuals with trading income of £1,000 or less in a tax year do not need to declare or pay tax on that income.
  • Individuals with trading income of more than £1,000 can elect to calculate their profits by deducting the allowances from their income, instead of the actual allowable expenses.

The trading allowance also applies to certain miscellaneous income from providing assets or services.

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In certain specified circumstances the allowances do not apply. These include income that attracts rent-a-room relief; income of a participator in a close company; any income of a partner from their partnership.

These rules apply for the purposes of a profession or vocation as they do for a trade.

ITTOIA 2005 S783A onwards sets out the various conditions in which this allowance applies. This indicates the £1,000 allowance related to gross receipts and not the profit. However, there are other factors to consider when looking at this. 

Where trading income exceeds £1,000, the legislation allows for so-called partial relief. (See ITTOIA 2005 S783AH.) 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.

The relief is not available for partnerships or rent-a-room schemes. (See ITTOIA 2005 S783AN).

If the exemption applies, then the taxpayer is not required to complete a tax return if this is the only untaxed income or has not been issued with the notice to file a return. (See HMRC manual page EM4551 on who needs to complete a tax return.)

If you have more than one trading business, the individual’s trades are combined and one threshold is applied. This seems a little unfair to someone, for example, who is employed and receiving a small amount of trading as well in comparison to those who have two trades that could take them over the allowance amount. 

No relief is available if the sole trader receives income from: 

  •  An employer or a spouse/civil partner’s employer.
  • A partnership in which they – or a connected party – are a partner.
  • A close company in which they – or an associate – are a participator.

Ben Chaplin is managing director of Croner Taxwise