Overlap profits – What are they and when is relief given?
Under the current rules for determining which profits of an unincorporated business are taxed in a particular tax year, some profits may fall to be taxed twice in the opening years of a business. These profits are known as overlap profits.
Once the business is up and running, the profits that are currently taxed for a particular tax year are those for the accounting period that ends in the tax year. This is known as the current year basis. For example, if an established sole trader prepares accounts to 30 June each year, he or she will be taxed on the profits for the year to 30 June 2021 in the 2021/22 tax year, as this is the period that ends in that tax year.
If the business chooses to change their accounting date once the business is up and running, there may be further overlap profits, or relief may be available for profits taxed twice in the early years.
As part of the move to Making Tax Digital for Income Tax Self-Assessment (MTD for ITSA), the basis period rules are to be reformed. Where overlap profits exist and have yet to be relieved, relief for those profits will be given in the transitional year.
Overlap profits in the opening years
In the opening year of an unincorporated business, the profits are taxed as follows.
|1||Date of commencement to following 5 April|
|2||· If there is an accounting date in Year 2 which is less than 12 months from commencement – first 12 months.
· If there is an accounting date in Year 2 which is at least 12 months from commencement – 12 months to the accounting date.
· If there is no accounting date in Year 2 – profits of the tax year (from 6 April at start of tax year in Year 2 to following 5 April).
|3||12 months to the accounting tax ending in the tax year|
Maud is a sole trader. She started trading on 1 June 2016. She prepares accounts to 30 April each year.
In the opening years, the following profits were taxed.
|Tax Year||Profits assessed|
|2016/17||1 June 2016 to 5 April 2017|
|2017/18||1 June 2016 to 31 May 2017|
|2018/19||12 month to 30 April 2018|
In both year 1 and year 2, the profits for the period from 1 June 2016 to 5 April 2017 are assessed. There are her overlap profits.
If accounts are prepared to 5 April (or to 31 March which is treated as equivalent to 5 April), there are no overlap profits.
Change of accounting date – Overlap profits
Overlap profits may arise on a change of accounting date if the new accounting date is less than 12 months from the end of the previous accounting period. This is illustrated by the following example.
Albert has been a sole trader for many years preparing accounts to 30 September each year. In 2020, he changed his accounting date to 30 April. The new accounting date of 30 April 2020 is less than 12 months from the previous accounting date of 30 September 2019.
The profits assessed in 2019/20 and 2020/21 are as follows:
|Tax Year||Profits Assessed|
|2019/20||Year to 30 September 2019|
|2020/21||12 months to 30 April 2020|
As a result of the change of accounting date, the profits for the period from 1 May 2019 to 30 September 2019 are taxed twice. These are overlap profits.
Change of accounting date – overlap relief
If on a change of accounting date, the new accounting date is more than 12 months from the old accounting date, and the trader has overlap profits which have yet to be relieved, overlap relief may be given on the change of accounting date. Overlap relief is given by deducting the overlap profits from the profits for the tax year in which the change of accounting date occurs.
However, the relief is restricted by reference to the number of days in the overlap period and the number of days for which the basis period for the tax year in which the change of accounting date exceeds 12 months.
Maud, from example 1, changes her accounting date to 30 October in 2021, preparing accounts for 18 months to 30 October 2021.
Her overlap profits are for the period from 1 June 2016 to 5 April 2017 – a period of 309 days.
Her new accounting period exceeds 12 months by 184 days.
Assuming her overlap profits are £30,000, she will be able to claim overlap relief of 184/309 x £30,000, i.e. £17,864 on her change of accounting date. Overlap relief is restricted to 184 days.
Overlap relief in final year
Under the current rules, if overlap profits have not been relieved when the business ceases, relief is given by deducting the overlap profits from the profits assessed in the final tax year.
Basis period reform
The basis period rules are being reformed, moving to a tax-year basis from 2024/25. The 2023/24 tax year will be a transitional year in which relief for any unrelieved overlap profits will be given.
Partner note: ITTOIA 2005, ss. 204—207; Finance Bill 2021—22, cl. 7 and Sch. 1.