If you don't choose the simple route, you can obtain a cashflow advantage, quite legitimately and within the law, because choosing a year end towards the beginning of the tax year means that you pay the tax liability later than you would if you aligned your year end with the end of the UK tax year. You still pay the same amount of tax over the full life of your business, regardless of what year end you choose: the difference is when the tax payments fall due in relation to when the underlying profits arise.
As a matter of Public Policy, HMRC prefer people to pay their tax sooner rather than later: so there are special rules that temporarily ‘penalise’ businesses choosing an earlier year end by taxing them twice when they start and only giving it back when their business ends - which could be years later when inflation has eroded its value. Despite this, many businesses choose an earlier year end because it's better for their personal circumstances.
This article explains how the simplest of those special rules work for businesses who are making profits. It doesn't cover what happens for businesses that are making a loss (that will be in a later article).
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The first thing I need to say about this topic is, proceed at your own peril! The current UK tax regime of Self Assessment has been designed to be used by non-professionals, but that doesn’t mean it’s easy or straightforward. You need to be absolutely sure you understand the rules and how your circumstances fit into them.
Because it’s such a tricky area, I’m going to start with further reading:
- There’s a good HRMC Helpsheet here that gives an introduction to this whole area - simple and complex.
- For more detail, look at this section of the HMRC’s own Manual here which Revenue employees use to work out the answers themselves. This whole system was introduced in 1998 and back then HMRC issued a large booklet full of examples called SAT1 which you can find here.
Start-ups & year ends - gaining the cashflow advantage from the beginning:
There are special rules (Commencement Rules) for when you don’t have the same year end as the end of the tax year. The rules apply differently if you have a trading period of more than 12 months, so you end up being taxed twice several times, but I’m keeping it simple and ignoring those complexities.
Let’s take the earlier example in the last article of a new business which starts on 1 October but this time, the owner chooses a 30 April year end not a 31 March one.
- In the last post, I talked about year end and trading or (accounting) periods: normally in the simple scenario your trading/ accounting period is the same as your basis period for tax.
- In this scenario HMRC split up your trading period into basis periods by reference to how many tax years the trading period covers. These basis periods overlap and cause the double taxation – the result of these overlapping basis periods is called ‘Overlap’ profits/ periods/ relief (in accounting speak).
- Tax Year 1 – you start on 1 October, you choose a 30 April year end, your first trading period is 1 October 2009 to 30 April 2010 (210 days). This is less than 12 months, but has a tax year end during it, on 5 April 2010, so it needs to be split into basis periods Your first basis period is 1 October 2009 to 5 April 2010 (186 days) and this is taxed in the 2010 tax year (due by 31 January 2011). Your year end for this tax year for the return is 5 April 2010.
- Tax Year 2 – HMRC looks at whether you have a year end during the tax year. So in this example, between the dates of 6 April 2010 and 5 April 2011 you have a year end of 30 April 2010. BUT even though you’ve already been taxed on the first six months of your first trading period in tax year 1 (2010), you are going to be taxed on the full 7 month trading period ending in this tax year 2 (2011) (this is your second basis period). So you are going to be taxed on the 186 days all over again, plus the rest that hasn’t already been taxed, making up the total 210 days. The 186 days’ worth of profits – which is your ‘overlap’ period - is taxed twice, once last year and once this year. You have to put the full 7 months profits & expenses in your 2011 tax return (due by 31 January 2012) and show the amount that was taxed twice as Overlap. Your year end for this tax year for the return is 30 April 2010.
- Tax Year 3 – your trading period will be 1 May 2010 to 30 April 2011 - (tax year 20102, filing by 31 January 2013) - a full 12 months that have no new overlap and you carry on like this for the rest of your business life.
All well and good, you know in principle that you’re going to be taxed twice, but how to tell HMRC?
- Well the good news is that HMRC know it’s tricky and have provided boxes especially for this on the Long version of the Self Assessment Tax Return pages, and give pretty good guidance in the HelpSheet that accompanies them. As long as you know your total profits for the trading period and the dates of the basis periods, you just fill in the boxes in Tax Year One.
- Overlap happens in your second tax year, not your first. There’s a special box on the Return for overlap, and the HelpSheet tells you how to work it out for Tax Year Two. In the example above, it would be 186 days out of 210 days taxed twice times by the full 210 days worth of profits. So if the profits were £2,000, your overlap profit figure would be £1,771 (186/210x2,000). That’s not the tax you pay, that’s the figure used to work out the tax. You would put £1,771 in the Overlap box in your second year’s tax return.
- The bad news is that if you fit this scenario and have been using the Short version, or have filed online and not looked at the HelpSheet, you may well have got your tax wrong and need to have another look at it and confess all to HMRC to regularise your position.
You might want to do this to change your initial accounting date to one earlier in the tax year to give you a cashflow advantage, or you might have chosen an initial accounting date that takes you into the special rules but you'd really rather keep it simple and move your accounting date to later in the tax year.
The basic principles of basis periods and overlap as explained above also apply to a change of accounting date, but the special rules for a change of accounting date are triggered by
- the date change itself rather than the trading period, and
- the calculation of the basis periods differs depending on whether the change means you have two year ends or no year ends at all in the tax year of change, and also on how long your business has been in existence.
- You may end up with multiple overlap periods. This may or may not be beneficial for your business depending on your exact personal circumstances. (See the further reading for examples and help on your specific circumstances).
- You need to be aware that you can only do it once every 5 years, and
- If you get it wrong – you will end up with an accounting/ trading period that doesn’t match your basis period for tax and with the need to do annual adjustments until you’re allowed to try again.