The sole trader's assets and liabilities - a tax law study on the importance of accounting to the demarcation of business activity

Abstract: Sweden is a typical small-business country and, based on the numbers, a clear majority of the companies operate as sole traders. Unlike limited companies and other legal entities, which classify all income as business income, the income or expenditures of private persons are classified as either business, service or capital income. The main objective of this thesis is to systematically examine the tax law rules demarcating which assets and liabilities are to be classified under business activity for a sole trader. This systematisation can identify whether, within the framework of the governing law, there are one or more guiding principles for how to solve the demarcation problem for various assets and liabilities. In Sweden, there is a legal connection between accounting and calculating income under tax law. This thesis pays particular attention to the importance of accounting to the demarcation under tax law. Even if there is no legal connection in this respect, there may be a practical connection, i.e. co-ordination between the accounting and tax law rules. The core of this thesis is the demarcation problem in terms of assets and liabilities. Both the number of issues involved and the substance are extensive. The demarcation has been derived mainly from the areas which were addressed in the special demarcation rules for assets (receivables and similar assets, tangible assets consisting of personal property, Shares in cooperative associations and futures) and liabilities. In my investigation, I have identified two main principles on which the demarcation of the sole trader’s assets and liabilities must be based: the asset’s use and benefit to the company and the underlying transaction. The latter demarcation rule contains two parameters. First, the item from which the receivable emanates must be classified as being within the sphere of business activity. Second, compensation -- for example in connection with the sale of the underlying asset -- must be taxed as business income. Some items, different kind of securities, fall outside the classification. The demarcation in these cases is made based on the character of the individual asset.