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W. E. (Walter Edward) Snelling.

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PRACTICAL
INCOME TAX



BY THE SAME AUTHOR

INCOME TAX AND SUPER-TAX PRACTICE.

Including a Dictionary of Income Tax, Spe-
cimen Returns, and a Supplement dealing with
the Finance Act, 1915, and the Finance (No. 2)
Act, 1915. In demy 8vo, cloth gilt, 450 pp.,
10s. 6d. net.

INCOME TAX TABLES, and Guide to the Deduc-
tion of Tax from Dividends, Interest, Ground
Rents, etc. For the use of Secretaries, Account-
ants, Commercial Houses and all Payers of
Income Tax and Super -Tax. In demy 8vo,
cloth gilt, 185 pp., 6s. net.

INCOME TAX, SUPER-TAX, AND INHABITED
HOUSE DUTY LAW AND CASES. A Prac
tical Exposition of the Law, for the use of
Income Tax Officials, Solicitors, Accountants,
etc. With an Analysis of the Schedules, Guide
to Income Tax Law, and Notes on Land Tax.
Including a Supplement dealing with the
Finance Act, 1915, and the Finance (No. 2) Act,
1915. New Edition, Enlarged and thoroughly
Revised. In demy 8vo, cloth gilt, 432 pp.,
10s. 6d. net.



LONDON

SIR ISAAC PITMAN & SONS, LTD.
1 AMEN CORNER, LONDON, E.G.



PRACTICAL
INCOME TAX

A GUIDE TO THE PREPARATION
OF INCOME TAX RETURNS



BY



W. E. SNELLING

AUTHOR OF " INCOME TAX PRACTICE/' ETC., ETC.



LONDON

SIR ISAAC PITMAN & SONS, LTD., 1 AMEN CORNER, E.G.
BATH, NEW YORK AND MELBOURNE



PRINTED BY SIR ISAAC PITMAN

& SONS, LTD., LONDON, BATH,

NEW YORK AND MELBOURNE



PREFACE

THE title of this book should give a true idea of its
purpose and scope. The reader will not be confused
by long quotations from Acts of Parliament, or from
judgments on appeal cases. But the general substance
of these has been incorporated in an exposition of
income tax law from a business point of view. The
requirements of the student have received special
consideration, the book containing many practical
examples and concluding with a set of test questions
(with solutions) covering the whole of the ground.
War legislation, Super-tax, and Excess Profits Duty
are also dealt with.



34Q753



CONTENTS



CHAP. PAGE

PREFACE ........ V

I. THE INCOME TAX LAWS AND THEIR ADMINISTRATION 1

II. THE ADJUSTMENT OF ACCOUNTS FOR INCOME TAX

PURPOSES RULES AND EXAMPLES ... 4

III. THE ADJUSTMENT OF ACCOUNTS (CONTINUED)

SPECIMEN ACCOUNTS ..... 8

IV. THE ADJUSTMENT OF ACCOUNTS (CONCLUDED)

PARTICULAR DIFFICULTIES . . . .12

V. THE AVERAGING OF ADJUSTED PROFITS EXAMPLES

NORMAL ASSESSMENT IN THE EARLY YEARS OF A

BUSINESS WHEN THE AVERAGE MAY BE DROPPED 15

VI. DROPPING THE AVERAGE SYSTEM THE EARLY YEARS

OF TRADING THE EXPIRING YEARS OF A BUSINESS 19

VII. DROPPING THE AVERAGE SYSTEM (CONTINUED)

WHEN A LOSS IS INCURRED RULES FOR REPAY-
MENT EXAMPLES EFFECT ON FUTURE AVERAGES 23

VIII. DROPPING THE AVERAGE SYSTEM (CONCLUDED)

WHERE A CHANGE IN PROPRIETORSHIP IS FOLLOWED

BY OR ENTAILS A SPECIFIC CAUSE OF LOSS WHERE

A DIMINUTION OF PROFITS IS DUE TO THE WAR . 31

IX. ALLOWANCES EXEMPTION ABATEMENT LIFE

ASSURANCE CHILDREN'S ALLOWANCE LOWER

RATES TO EARNED INCOMES LOWER RATES TO

SMALL UNEARNED INCOMES . . . .35

X. HOW TO COMPLETE A RETURN FORM EXAMPLES . 39

XL WIFE'S INCOME ....... 43

XII. THE ASSESSMENT OF FIRMS GENERAL RULES

EXAMPLE FIRMS' RETURNS . . . .47

XIII. THE ASSESSMENT OF FIRMS (CONCLUDED) WHERE

THE FIRM HAS UNEARNED INCOME AND PAYS

INTEREST WHERE THE CURRENT YEAR'S BASIS

OF THE DIVISION OF PROFITS IS NOT KNOWN

WHERE A NEW PARTNER ENTERS ... 52

vii



Vlll



CONTENTS



CHAP.
XIV.



XV.



XVI.



XVII.



XVIII.



XIX.



XX.



XXI.



XXII.



THE DEDUCTION OF TAX FROM PAYMENTS MADE BY

TAXPAYERS RULES UNDER WHICH DEDUCTION IS

MADE RATES OF DEDUCTION FIRMS PAY-
MENTS NOT MADE OUT OF TAXED INCOME . . 60

THE DEDUCTION OF TAX (CONCLUDED) PAYMENTS

FROM WHICH TAX MAY BE DEDUCTED WHERE

THE RATE CHANGES GENERAL RULES RESPECTING

INTEREST ....... 65

COLONIAL AND FOREIGN INCOME BASIS OF ASSESS-
MENT WAR DISTURBANCES . 70



REPAIRS RENEWALS REPLACEMENTS -

DEPRECIATION OBSOLESCENCE



-ADDITIONS



XXIII.



ASSESSMENT ON PROPERTY THREE TAXES SCHED-
ULE A SCHEDULE B HOUSE DUTY TENANT'S

LIABILITY CHANGES IN OCCUPATION LOST RENT

OWNER-OCCUPIERS EXEMPT TENANTS AND

LANDLORDS LANDLORD'S GROUND RENT AND

MORTGAGE INTEREST .....

REPAYMENT CLAIMS GROUNDS ON WHICH REPAY-
MENT MAY BE CLAIMED LIMITATIONS WITH

REGARD TO PLACE OF RESIDENCE AND TIME LIMIT

COMPLETING THE FORM PROOF REQUIRED,

VOUCHERS, ETC. ......

SUPER-TAX GENERAL SCHEME WHAT IS ASSUMED

TO BE THE INCOME OF ANY PARTICULAR YEAR

DEDUCTIONS HOW TO MAKE A RETURN GENERAL

RULES LIMITS AND RATES IN VARIOUS YEARS

WAR PROVISIONS ......

THE INSTALMENT SYSTEM QUARTERLY ASSESSMENTS

ON WEEKLY WAGE-EARNERS EMPLOYED IN
MANUAL LABOUR . . . . .

EXCESS PROFITS DUTY PROFITS MADE " DURING

THE WAR " ACCOUNTS COVERING LESS THAN A

YEAR PROFITS MADE " BEFORE THE WAR "

THE PROFITS STANDARD PERCENTAGE STANDARD

RULES REGARDING CAPITAL CALCULATING THE

PROFITS WHO ARE LIABLE ? PROCEDURE.

TEST EXERCISES AND SOLUTIONS ....
INDEX



74



82



89



99



105



109
117
127



PRACTICAL INCOME TAX

CHAPTER I

THE INCOME TAX LAWS AND THEIR ADMINISTRATION

WITH the increasing importance of the income tax laws a
general knowledge of the subject is rapidly becoming an
essential qualification to anyone holding, or hoping to hold,
the position of responsible clerk or accountant to a concern
of any standing. To mention one matter only, the absolute
requirement that a claim to a lower rate should be rendered
in the prescribed form, is making it strongly advisable that
someone in every such concern should know how to draw
out a return correctly. The subject is undoubtedly an
intricate one, but a sufficient knowledge of it may be acquired
without very much effort. Perhaps the fact that such a
satisfactory knowledge of the commercial aspect of the
taxing laws is not often met with in the business world,
may make the study still more worth while.

Income Tax Laws.

A preliminary note as to the income tax laws and their
administration may be useful to the reader. Income tax is
an annual charge, the sole sanction for which is contained
in the annual Finance Act or Acts. Without such sanction
no tax may be levied. Continuity is secured, however, by
the following provisions

(i) A permanent authority for the necessary administrative
and preparatory work to be proceeded with before the passage
into law of the Finance Act reimposing the tax ;

1



2 PRACTICAL IN.COME TAX

(ii) A permanent authority for tax to be levied at the
previous year's rate for the first month of the fiscal year ;

(iii) An authority for a resolution of the House of Com-
mons reimposing the tax at a stated rate to have the force
of law for four months or until the Finance Act passes into
law, whichever is shorter.

(iv) A provision in the Finance Act of each year continuing
the general body of income tax law for that year, with any
necessary additions or alterations.

The result is that the existing income tax legislation is
contained in a very large number of Acts from 1842 to date.
There is also a great deal of " case law/'

The Administration.

There are three classes of officials concerned in this matter
(i) The representatives of the Crown, including

(a) The Treasury which, with the Chancellor of the
Exchequer, exercises a general authority.

(b) The Board of Inland Revenue which, with its clerical
staff, actually directs and carries into operation the work
required to give effect to the provisions of the Acts.

(c) The district Surveyors of Taxes who (acting under
superior officers at Somerset House), represent the Crown
in all matters regarding the making of assessments, and the
determining of appeals. These are the officials to whom
the taxpayer should go whenever a question arises as to
particular assessments. They are Civil Servants paid by
fixed salaries.

(ii) The local Commissioners of Taxes, who are unpaid
gentlemen of some standing (there is a property qualifica-
tion), and to whose discretion is left the determination of all
differences between the taxpayer and the representatives
of the Crown. The legal Courts may be appealed to on any
question of law. The Commissioners have a Clerk to advise
them, to issue notices of assessment, etc., to the taxpayer,



INCOME TAX LAWS AND THEIR ADMINISTRATION 3

and to carry out other clerical work with regard to the assess-
ment. The Clerk is paid by the Board of Inland Revenue,
but he is appointed annually by the local Commissioners.

(iii) The local Assessors and Collectors whose duty it is to
serve and obtain forms of Return, to give general advice
to the authorities concerning local matters and to collect
the tax due. These officials are not Civil Servants. They
are usually appointed by the local Commissioners, but are
paid by the Board of Inland Revenue.



CHAPTER II

THE ADJUSTMENT OF ACCOUNTS FOR INCOME TAX
PURPOSES RULES AND EXAMPLES

THE present chapter may well open with the question which
most taxpayers ask at their first contact with the income tax
regulations : " Why cannot I pay on what I make ? Here
are my books and this is my profit ! Why not calculate the
tax on that and close the matter ? "

Profit.

Now it must first be realised that some standard is necessary
if the incidence of the tax is to be at all equitable. Tempera-
ment has a good deal to do with the drawing out of a Profit
and Loss Account. A sanguine trader may reckon his profit
at 1,000, whereas his more cautious neighbour would have
reduced it to 700 by adding 300 to Reserve. If the Income
Tax Commissioners were allowed to view the result only, it is
certain that the whole business world would commence to
build up reserves at an unprecedented rate. Again, one
trader may charge his subscriptions to his business, while
another subscribes from his private pocket only. It is
obvious that in these and many other matters the law must
step in with its standard. If the standard is harsh in some
ways it must be remembered that its application is general.
All this is intended to induce the reader to realise that, while
the taxing laws are undoubtedly imperfect, they are yet
founded for the most part on reasonable considerations. A
little sympathy with the subject will make comprehension
very much quicker, besides assisting the reader to an insight
into the principles of the law which will be invaluable.

Turning therefore to the question asked above we say
" Here is your profit, certainly, but have you reduced it to its
present figure by charging any expenses not allowed according



ADJUSTMENT OF ACCOUNTS FOR INCOME TAX PURPOSES 5

to the income tax standard ? Or is your profit unduly inflated
through omission to charge something which is allowed by
that standard ? " If either question is answered in the
affirmative an adjustment is necessary, viz.

(a) The addition to the profit of any expenses charged but
not allowable for income tax purposes ;

(b) The deduction from the profit of any expenses allowable
for income tax purposes but which have not as yet been
charged.

As a general rule we adjust, in this manner, the accounts
of the past three years and average the results, as will be shown
later.

The adjustment of accounts for income tax purposes is
governed by considerations which may be presented in the
form of five rules. Commencing with the profit arrived at by
the trader for his own purposes

(1) Capital matters ; add any expenses on account thereof
which have been charged against revenue in the accounts ;
deduct any receipts on account thereof included as trade
receipts ;

(2) Personal matters ; add, any expenses on account thereof
which have been charged against revenue in the accounts ;

(3) Irrelevant matters ; add any expenses not exclusively
incurred in earning profits but which have been charged against
revenue in the accounts ;

(4) Interest and similar payments from which tax may be
deducted by the payer ; add any such amounts included in
the expenses charged in the accounts ; deduct any such
amounts included in the trade receipts (the deduction of tax
from such payments is explained in a later chapter) ;

(5) Reserves ; add any sums which have been added to
reserve ; deduct any revenue expenses or losses which have
been charged against reserve.

As regards rule (1) it should be observed that capital charges
include such matters as the following, viz.

Preliminary expenses and other expenditure incurred in
setting up business ;



6 PRACTICAL INCOME TAX

All expense of obtaining capital, including interest
thereon ;

All additions and improvements to assets.
Capital receipts would include

A premium on the issue of the share capital of the
business ;

Repayment of loans, etc.
Under rule (2), personal expenses include

Salaries, drawings or interest on capital credited to the
proprietor or his wife ;

Income tax ; and

A proportion of rent, rates, lighting, etc., where the
proprietor resides on business premises.
Under rule (3) would fall charitable subscriptions, etc.
Rule (4) includes

Ground rent ;

Interest on fixed loan ;

Mortgage interest ;

Debenture interest ; and

Patent royalties.
Among the items not to be assessed again are

Taxed dividends ;

Taxed rents, etc.
Rule (5) includes

Bad and Doubtful Debts Reserves ;

Suspense Accounts ; and

General Reserves.

Examples.

These rules will now be elaborated in a few examples taken
from everyday business experience. It is suggested that the
reader should decide how he himself would treat each item
before he refers to the solutions which follow.

It is required to state what adjustments are necessary for
income tax purposes in the following cases.

(a) A firm's accounts show a profit of 600, after charging
legal expenses 18, representing 10 for the collection of



ADJUSTMENT OF ACCOUNTS FOR INCOME TAX PURPOSES 7

debts, 3 for a deed of partnership, and 5 in connection with
a lease of trade premises.

(b) A trader's accounts show a profit of 210 after charging
10 interest on his capital, 52 wages to his wife, and 78 wages
to his son.

(c) A company's accounts show a profit of 1,200 after 17
has been charged against revenue as the cost of issuing
debentures and 40 as debenture interest.

(d) A trader's accounts show a profit of 500 after 100 has
been added to Bad Debts Reserve ; during the year 38 has
been written off such Reserve to meet actual bad debts ; the
trader owns his trade premises (assessed 70 net) and has made
no charge for rent except 10 ground rent paid by him.

Adjustments should be made as follows

(a) Add 3 and 5 to the 600 in accordance with rule (1).

(b) Add 10 and 52 to the 210 in accordance with rule (2).

(c) Add 17 to the 1,200 in accordance with rule (1) and
40 in accordance with rule (4).

(d) Add 100 to the 500 (rule (5)), deduct 38 (rule (5) ),
deduct 70 (rule (4) ), and add 10 (rule (4) ).



CHAPTER III

THE ADJUSTMENT OF ACCOUNTS (CONTINUED) SPECIMEN
ACCOUNTS

IT will be assumed that the book-keeper or accountant has
open before him the following Trading and Profit and Loss
Accounts. The profit shown thereby is 1,706, but it is by
no means certain that this is the profit according to the
income tax standard. The accounts referred to must be
closely scrutinised. Readers desiring to master the subject
will find it good practice to make the necessary adjustments
themselves before referring to the solution which follows.
(For Profit and Loss Account, see page 10.)

The rules of adjustment referred to in the previous chapter
may be summarised as follows. Exclude from revenue
accounts (1) capital matters ; (2) personal matters ; (3)
irrelevant matters ; and (4) payments and receipts from which
tax has been deducted ; and (5) neutralise any entries affecting
reserves. With these directions in mind the accounts may be
scrutinised.

TRADING ACCOUNT

















Jan. i


To Stock on hand


2,400


Dec. 31


By Sales .


21,174


Dec. 31


,, Purchases


9,3i4




Stock on hand


2,735




,, Wages and Supervision


8,017










Rent of Factory .


450










,, Ground Rent on Ware












house owned by Firm


15










Rates, Taxes, Lighting












Heating, etc.












,, Replacements of Ma


127










chinery


150










Gross Profit .


3,436












23,9<>9






23,909







Trading Account.

We pass the credit entries as satisfactory, likewise the first
two debit entries.

Wages and Supervision. This item may be passed provided
that no part thereof is paid to the proprietors. In this case
we will assume that two partners each take 150 for supervision.



ADJUSTMENT OF ACCOUNTS 9

Rent of Factory. This is a proper charge.

Ground Rent on Warehouse Owned by Firm. In paying this
ground rent the firm should have deducted tax (i.e., instead
of paying 15 they should have paid 15 less tax on 15). It
follows that it must not be set against the profits to be charged
under Schedule D. On the contrary the tax deducted must
be paid over to the Revenue. This will be done as follows.
The warehouse will be assessed to duty under Schedule A
(property tax) say at 90 gross, 75 net. The firm as owners
will bear tax on 75 less the proportion recovered on the
ground rent. Having thus met their liability as owners, the
firm must not pay tax again on the value of the warehouse as
traders, but should charge the 90 (or else the 75, plus the
cost of repairs) as the expense to the trade for the use of the
warehouse. The requisite adjustments, therefore, will be
the addition of ground rent improperly charged and the
deduction of 75 (as repairs are assumed to have been charged)
omitted to be deducted in the accounts.

Rent, Rates, Taxes, etc. Income tax is a personal expense
and may not be set against profits. We may assume that 4
tax under Schedule A has been charged.

Replacements of Machinery. This item must be carefully
looked into. If an allowance is made for depreciation (see
next page) the cost of replacements may not be charged against
revenue for income tax purposes. Otherwise the charge may
be passed, provided that it represents replacements only and
not additions or improvements.

Profit and Loss Account.

As we have seen the Trading Account, the first credit item
is obviously satisfactory. If we had not seen the Trading
Account a correct adjustment could not be made.

Dividends. Tax has no doubt been deducted from this
item ; it must therefore be deducted from the profit for
assessment purposes.

Rates and Taxes. The proportion of this representing
income tax must be disallowed as an expense (say 92).
2 (1527)



10



PRACTICAL INCOME TAX



PROFIT AND LOSS ACCOUNT

















Dec. 31


To Rent of Office
Rates and Taxes


100

134


Dec. 31


By Trading Account
,, Dividends


3,436
124




Salaries .


743










Interest


137










Depreciation of Ware-












house Lease


20










Ditto Machinery


50










Ditto Furniture


5










Ditto Investments


10










Reserve for Bad Debts


100










,, Contingencies


IOO










Interest on Capital, A B


240










CD


138










Lighting, Heating, etc.


13










Stationery, etc.


29










Gratuities and Dona-












tions .


35










Balance Net Profit .


1,706








. 3>56 ,


'



Salaries. Disallow all amounts credited to partners (say
200 each).

Interest, 137. Under rule (4), deduct any items received
which have already suffered tax, and add any items paid from
which tax has been deducted by the firm. If the 137 is
interest on a bank over-draft required for trade purposes it
may be passed. If it is interest on a fixed loan, tax should
have been deducted therefrom and the item must be disallowed
for income tax purposes. If it is the balance of the Interest
Account, that account must be scrutinised and each item
therein dealt with under rule (4) . In this particular case the
137 may be assumed to represent interest on a bank
overdraft used for trade purposes.

Depreciation of Warehouse Lease. \ ~ u , , , .

' .. / These deductions are

.. Furniture. y

\ disallowed under rule (1) .



Furniture.
Investments.



Depreciation of Machinery. Rule 1 prohibits any deduction
on ..this account, but under a special enactment a deduction
may be made from the assessment. The charge must be
disallowed here, and an allowance obtained after the average
is struck. The matter should be arranged with the
authorities. This subject is so important that special



ADJUSTMENT OF ACCOUNTS



11



consideration is given to it in Chapter XVII. An allowance
for the depreciation of fixtures may now be claimed.

Reserve for Bad Debts. Disallow this item, rule (5) but allow
any revenue charges out of such reserve. It may be assumed
that 80 has been written off on account of actual and specific
bad debts, and that a debt of 12 formerly written off but now
recovered has been added straight to the reserve and not
carried to the Revenue Account. 100 and 12 must be
added and 80 deducted.

Reserve for Contingencies. Disallow this, under the same
rules necessitating the adjustments for Bad Debts Reserve.

Interest on Capital. Disallow this under rule (1) or rule (2).

Gratuities and Donations. The 35 may be assumed to
include 20 paid to employees by way of bonus, 10 to a local
Relief Fund, and 5 to a particular hospital, in return for
which special benefits will be allowed to the firm's employees.
The 10 should be disallowed.

Adjustment.

The adjustment will be as follows

Profit per A\c .

Add Wages to Partners



Ground Rent

Tax, Schedule A .
D

Salaries to Partners

Depreciation of Lease

Furniture

Investments

,, Machinery .

Reserve for Bad Debts

,, ,, Contingencies
Interest on Capital, A B
CD
Donation ....

Deduct Annual Value of Warehouse
Dividends
Bad Debts



Profit for Income Tax purposes



1,706

300

15
4

92
400

20
5

10

50
100

12
100
240
138

10

75

124

80



3,202



279
2,923



CHAPTER IV



THE ADJUSTMENT OF ACCOUNTS (CONCLUDED)
PARTICULAR DIFFICULTIES

OUR study of the adjustment of accounts for income tax
purposes may be concluded by notes on a few points which
present particular difficulties. This done, we may pass to
questions of averages, returns, and similar matters.

Interest Account.

Passing reference to this was made in the preceding chapter.
If the trader's Profit and Loss Account shows a profit of 1,450
after a charge on the debit side " To interest 34, " it will not
suffice to disallow that charge and to assume the profit for
income tax purposes to be 1,450 plus 34. It is necessary
to scrutinise the Interest Account, and the matter is simplified
if it is remembered that the carrying of the balance of that
account to the Profit and Loss Account is equivalent to the
carrying of all its debit items to the debit side and all its
credit items to the credit side of the Profit and Loss Account.
In considering the following account, therefore, we shall
recognise that all interest received is included in the receipts
and all interest paid in the payments recorded in the Profit
and Loss Account.



INTEREST ACCOUNT



To Short Trade Loan .
A. Baker (2,400
5%, less tax) . .
, Bank Overdraft



at



113
23



225



By



Debenture Interest,

B C & Co., Ltd.

(less Tax) . . . .
Dividends, B C & Co.,

Ltd. (free of tax) .
D. Evans (500 at 7%,

less tax) .
Balance to P. & L. A/c



54
104

33
34

225



12



ADJUSTMENT OF ACCOUNTS 13

The rules for adjustment are to exclude from receipts all
interest already taxed by deduction, and to exclude from
payments all interest from which the trader has deducted tax.
The reason for the first is obvious. As regards the latter, as
well as paying tax on his own net profit, the trader must hand
over the tax he has deducted from his creditors.

ADJUSTMENT

Profit per Profit and Loss Account
Add Interest paid " less tax " .

1,563

Deduct Taxed Debenture Interest . . 54
Dividends . . . .104
Interest . . . .33

191




Profit for Income Tax purposes . . . ^1,372

Tax is not deducted from interest paid on short trade loans
or a bank overdraft. A dividend paid " free of tax " is merely
one on which the company has paid tax out of undivided profits
without making a corresponding deduction from the profits
distributed as dividend.

Cash Account.

Those traders who keep record of cash receipts and pay-
ments only should observe the rules of adjustment given in
regard to Profit and Loss Accounts, but they must also take


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