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Last updated: 21 Jul 2021
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The end of overlap profits for the self-employed?

HMRC has released a consultation proposing that all self-employed businesses will be taxed on profits earned in a tax year, rather than on the profits of the accounting year ending in that tax year. Here, James Currie outlines everything you need to know about the new proposal.
How does the tax system currently work?

How does the tax system currently work?

The UK’s tax year ends on 5 April and while many businesses choose 31 March as a year end to broadly tie in with that date, many other businesses choose a different accounting year end date for commercial reasons, for example 31 December.

When an individual starts to trade or joins a partnership and the year end for the business is not aligned with the tax year, some profits are taxed twice – in the first and second tax years of trading. These profits are ‘overlap profits’. Thereafter, an individual is subject to tax on 12 months of profits based on the business’s accounting year end ending in the tax year.

The overlap profits are carried forward and set against future profits in certain circumstances, such as leaving the business, the business ceasing or a change in the accounting year.  

About the author

James Currie

+44(0)20 7556 1319
Curriej@buzzacott.co.uk

How does the tax system currently work?

The UK’s tax year ends on 5 April and while many businesses choose 31 March as a year end to broadly tie in with that date, many other businesses choose a different accounting year end date for commercial reasons, for example 31 December.

When an individual starts to trade or joins a partnership and the year end for the business is not aligned with the tax year, some profits are taxed twice – in the first and second tax years of trading. These profits are ‘overlap profits’. Thereafter, an individual is subject to tax on 12 months of profits based on the business’s accounting year end ending in the tax year.

The overlap profits are carried forward and set against future profits in certain circumstances, such as leaving the business, the business ceasing or a change in the accounting year.  

What is HMRC’s proposal?

What is HMRC’s proposal?

The proposal is to remove the existing basis period rules and change to a ‘tax year basis’. This would mean the profit or loss for the business is the profit or loss arising in the tax year, regardless of the accounting date. Where a business has a year end other than 31 March (which is accepted as being 5 April for these purposes), profits will be apportioned between tax years.

This will prevent overlap profits from accruing in the future and will result in offset of any unused overlap profits for those in business when the change is made. Those affected by the proposal include sole traders, partners in partnerships, members of LLPs and other unincorporated entities with trading income, such as trading trusts and estates.

When would this take place?

When would this take place?

The transition will occur in the 2022/23 tax year, which begins on 6 April 2022:

  1. For 2022/23, businesses that do not have an accounting year end date aligned to the tax year would be brought into line with the tax year basis with overlap profits being offset.
  2. For 2023/24 and future years, all individuals and businesses will be on a tax year basis. This will coincide neatly for HMRC as Income Tax moves across to Making Tax Digital from 6 April 2023.
How would the new rules operate?

How would the new rules operate?

Taking an example of 31 December:

2022/23 tax year (the transitional year)

  • 12 months profits to 31 December 2022;
  • Plus: 1 January to 5 April 2023 (generally pro-rata based on taxable profit to 31 December 2023);
  • Less: Overlap profits brought forward.

For businesses with higher profits in 2022/23 due to the change in basis, an election to spread those additional profits over a period of up to five years is proposed.  

There will be a balance between the cash flow implications of paying all the tax in one go against the risk of higher tax rates (due to rate changes and/or higher profits) in the future.  We can help with projections.

2023/24 tax year (tax year basis)

  • 6 April 2023 to 5 April 2024 (again, generally pro-rated from the two accounting years)
What next?

What next?

This is only a consultation, but the release of draft legislation suggests change is likely and businesses may wish to establish the likely impacts on their cash flows of the proposed change.

We will continue to monitor the position and provide updates once we have further details.

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