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Advanced Taxation (UK) · Income tax: income from self-employment

Adjustment of Trading Profits for Sole Traders and Partners

Updated 11 October 2026 · Fact-checked

Adjustment of profits turns the accounting profit into taxable trading profit. Start with net profit, add back disallowable expenses, deduct non-trading or separately taxed income, then deduct capital allowances. Unincorporated traders can use the cash basis or the trading allowance instead. Partners are taxed on their share of the adjusted profit.

Understand Adjustment of Profits for Sole Traders and Partners

Accounting profit follows accounting rules. Taxable trading profit follows tax rules. The two differ, so you start with the accounts and adjust them.

The main test for an expense is whether it is incurred wholly and exclusively for the purposes of the trade. Expenses that are capital in nature are not deductible. Private costs, entertaining, fines and similar items are added back. Depreciation is always added back, because tax gives relief through capital allowances instead.

Some income in the accounts is not trading income. Examples are bank interest and rent. These are removed from trading profit because they are taxed under their own rules. Gains on disposal of fixed assets are also deducted, as they fall under capital gains rules.

Sole traders can usually choose a simpler basis. The cash basis taxes receipts less payments rather than accruals. It is the default for eligible small traders unless they elect out. The trading allowance of £1,000 can be used instead of deducting actual expenses on small gross income. Check the scenario to see which basis is used.

Partnerships first compute the profit of the whole firm as if it were one trader. The adjusted profit is then shared between partners under the profit-sharing arrangements for the period. Each partner is taxed on their own share.

Key rules to remember

Adjusted trading profit
Net profit per accounts + disallowable expenditure − non-trading and separately taxed income − capital items credited = profit before capital allowances; then − capital allowances (+ balancing charges) = taxable trading profit
Capital allowances are deducted after the adjustment. Rates come from the tax tables ACCA provides.
Basic deductibility test
Expense is allowable if incurred wholly and exclusively for the purposes of the trade and is revenue in nature
Where an expense has both private and business use, only the business part is allowed.
Cash basis profit
Cash receipts − cash payments for allowable expenses (with specific rules for capital items)
Applies to eligible unincorporated traders unless they elect for accruals.
Trading allowance
Gross trading income up to £1,000 is fully relieved; above that, deduct £1,000 instead of actual expenses (if beneficial)
The £1,000 figure is a core ATX rule. Check the tax tables and the question for conditions.
Partnership profit split
Adjusted firm profit is allocated using each partner's profit-sharing ratio and any salary or interest entitlement for the period
Allocate the profit after capital allowances. Salaries and interest are shared first, then the balance by ratio.

How to solve Adjustment of Profits for Sole Traders and Partners questions

Use the same layout every time. It earns method marks even if one number is wrong.

  1. 1Read the requirement and note which tax year or period and which basis (accruals or cash) applies.
  2. 2Start with the net profit per the accounts.
  3. 3List each expense in the accounts. Add back each disallowable item, with a short reason such as 'private' or 'capital'.
  4. 4Deduct income that is not trading income or is taxed elsewhere, such as interest received, rent and gains on disposal.
  5. 5Compute capital allowances separately and deduct them. Add any balancing charges.
  6. 6Check for deductions not in the accounts, such as an owner's private use adjustment, and apply the trading allowance if relevant.
  7. 7For partnerships, allocate the adjusted profit between partners using the sharing rules.
  8. 8State the final taxable trading profit and move it to the income tax computation.

Quickest way: Three-column adjustment table

When to use it: Use it when you are given a list of expenses and must adjust profit quickly.

  1. Draw three columns: Item, Add, Deduct. Put net profit at the top.
  2. Go down the list once. Tick allowable items and put nothing for them.
  3. Put disallowable items in the Add column and non-trading income in the Deduct column.
  4. Total each column and compute profit before allowances.
  5. Deduct capital allowances last and write the answer.

Common mistakes in Adjustment of Profits for Sole Traders and Partners

  • Deducting depreciation as an expense

    It is an expense in the accounts, so students leave it in.

    Fix: Always add back depreciation. Relief comes through capital allowances.

  • Leaving non-trading income in trading profit

    Students forget it is in the accounts' profit figure.

    Fix: Scan the income side. Deduct interest, rent and gains on disposal.

  • Disallowing the full amount of a mixed-use cost

    Students apply an all-or-nothing approach.

    Fix: Allow the business proportion and add back only the private part.

  • Using the cash basis rules without checking eligibility or election

    Students assume it applies automatically.

    Fix: Read the facts. Apply the basis stated, and note that an election out is possible.

  • Taxing partners on cash drawings

    Drawings look like a payment of profit.

    Fix: Partners are taxed on their profit share. Drawings are not deductible and not taxed separately.

  • Forgetting the 'wholly and exclusively' reason in written answers

    Students write numbers only.

    Fix: Add a short reason for each adjustment. The exam rewards explanation and professional skills.

Worked examples

Example 1

Asha is a sole trader. Her net profit per the accounts is £62,000. It is after charging depreciation £4,000, entertaining customers £1,500, private use of a van by Asha £800 and staff Christmas party £600. It includes bank interest received £300 and a gain on disposal of equipment £2,000. Capital allowances are £5,000. Compute her taxable trading profit.

Show the solution
  1. Start with net profit: £62,000.
  2. Add depreciation: £4,000 (capital item, replaced by allowances).
  3. Add customer entertaining: £1,500 (disallowable).
  4. Add private use of van: £800 (not for the trade).
  5. Staff party: £600 is allowable, so no adjustment.
  6. Total additions: £4,000 + £1,500 + £800 = £6,300. Profit becomes £68,300.
  7. Deduct bank interest £300 and gain on disposal £2,000: £2,300. Profit becomes £66,000.
  8. Deduct capital allowances £5,000: £61,000.

Answer: Taxable trading profit is £61,000.

Example 2

X and Y are in partnership sharing profits 60:40 after salaries of £10,000 to X and £4,000 to Y. The adjusted trading profit of the firm for the year, after capital allowances, is £64,000. Allocate the profit between the partners.

Show the solution
  1. Total salaries: £10,000 + £4,000 = £14,000.
  2. Remaining profit to share: £64,000 − £14,000 = £50,000.
  3. X's share of the balance: £50,000 × 60% = £30,000.
  4. Y's share of the balance: £50,000 × 40% = £20,000.
  5. X total: £10,000 + £30,000 = £40,000.
  6. Y total: £4,000 + £20,000 = £24,000.
  7. Check: £40,000 + £24,000 = £64,000.

Answer: X is taxed on £40,000 and Y on £24,000.

Exam tips

  • Show each adjustment with a one-line reason. ATX awards marks for explanation and for professional skills.
  • Use the pro forma every time, and do not drop items you treat as allowable. Say 'allowable' for them in the working.
  • Read the scenario for the basis. If the cash basis or trading allowance applies, say so and apply the right rules.
  • Put capital allowances in a separate working and link the figure in.
  • For partnerships, always check the sharing rules for the period and compute salaries first.

Practice questions from Income tax: income from self-employment

Adjustment of Profits for Sole Traders and Partners in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Adjustment of Profits for Sole Traders and Partners: frequently asked questions

What is the difference between allowable and disallowable expenses for a sole trader?

Allowable expenses are incurred wholly and exclusively for the trade and are revenue in nature. Disallowable expenses, such as private costs, capital items and entertaining, are added back to the accounting profit. Mixed-use costs are split.

Do I add back depreciation?

Yes, always. Depreciation is an accounting charge. Tax relief for the cost of assets is given through capital allowances.

What is the cash basis for the self-employed?

The cash basis taxes the trader on receipts less payments for the period rather than on accruals. It applies by default to eligible traders unless they elect out, so check the scenario.

How are partners taxed on trading profit?

The firm's profit is adjusted first, then shared between partners under the profit-sharing rules for the period. Each partner is taxed on their own share.