Calculating taxable self-employed or partnerships profits is usually relatively straight-forward if the accounting date – the date to which accounts are prepared – falls between 31 March and 5 April. However, overlap profits can arise where your business year end date is not the same as the end of the tax year.
Overlap profits can arise in the first 2 or 3 years of the business or in any year in which there is a change of taccounting date.
For example, if your business started 1 January 2018 and your chosen year end date is 31 December, the basis periods for tax purposes are:
- 2018/19 – 1 January 2019 to 5 April 2019 – i.e from the start date up to the end of that tax year
- 2019/20 – 1 January 2019 to 31 December 2019 – i.e the first 12 months of trading
So the profits from 1 January 2019 to 5 April 2019 are therefore taxed twice. This is known as “overlap profit”.
Overlap relief can be used to reduce the profits on your final tax return when the business ceases trading or if the accounting period changes. Overlap relief is a mandatory deduction. The full amount of the relief available for a particular tax year must be given as a deduction for that tax year. No part of the deduction can be waived. HOWEVER, you or your accountant will need to keep a record of them as HMRC don’t always know what they are, especially if your business started many years ago.
Bear in mind that overlap profits may well be quite small compared with the level of profits you are currently making, due to the effect of inflation over time, and the fact that you may have made little or no profit in your first year of trading.
If overlap profits were created some time ago, and profits have been declining in recent years, it may be prudent to consider a change of accounting date closer to, or at the end of, the tax year. In this way, the overlap relief can be claimed and tax liabilities reduced at a beneficial time for the business or partnership. There can also be Income Tax and National Insurance savings.
Overlap profits will be important in the transition to declaring profits on a tax year basis from April 2024 in readiness for MTD for Income Tax. Contact us if you’d like some advice on this tricky area or need help calculating your overlap relief and planning how and when to use it.