Case Study
John Smith the plumber started to trade on 1st November 2008 and is considering the date to which he intends to prepare his first set of accounts. His options, he has decided, are:
• 30th April 2009;
• 31st December 2009; or
• 31st May 2010.
Depending upon the date John chooses, a proportion of his first three tax years’ taxable profits may be taxed twice; such profits are referred to as ’overlap profits’.
Taxable Profits Taxed Twice
30th April 2009 - If John chooses 30th April as the date to which he prepares his accounts each year, in the first three tax years his overlap profits are those which arise in the periods 1st November 2008 to 5th April 2009 and 1st May 2009 to 31st October 2009, in all, approximately 11 months worth of profits.
31st December 2009 - If John chooses 31st December 2009 as the date to which he prepares his accounts each year, in the first three tax years his overlap profits are those which arise in the period 1st January 2009 to 5th April 2009, approximately 3 months' worth of profits.
31st May 2010 - If John chooses 31st May 2010 as the date to which he prepares his accounts each year, in the first three tax years his overlap profits are those which arise in the period 1st June 2009 to 5th April 2010, approximately 10 months’ worth of profits.
Of John’s suggested three options the option producing the lowest double tax is an accounts date of 31st December 2009.
Assuming average monthly taxable profits of, say, £2,000 and a basic rate of income tax of 20% each of the options produce an extra tax charge of £4,400, £1,200 and £4,000 respectively. This extra tax charge is only effectively refunded as and when John ceases to trade (which may be many years hence) or if he changes the date to which he prepares his accounts (which may possibly, depending upon the new date chosen, make the overlap profits position even worse).
Optimal Accounts Date
If John chose an accounts date of 5th April 2009 his overlap profits would be nil; his taxable periods for the first three tax years would be 1st November 2008 to 5th April 2009; 6th April 2009 to 5th April 2010 and 6th April 2010 to 5th April 2011 respectively (i.e. no overlapping periods).
Trading Losses
Unfortunately, if John makes trading losses in his early years of trading he is only granted relief once for such losses (e.g. by offsetting the loss against future trading profits).
Ceasing to Trade
Eventually, John may simply cease to trade or may sell his business (which causes him to be treated as ceasing to trade). There are special rules which apply to the tax year of cessation. However, in broad terms, if John trades until his taxable profits for this tax year equal his overlap profits, no income tax will be due for the tax year of cessation.
For example, if John decided to use 30th April 2009 as his accounts date (and using the figures above) he could wait until his taxable profits for the tax year of cessation equal £22,000 against which his overlap profits of £22,000 may be deducted leaving no income tax charge on his final £22,000 of taxable profits.
Practical Tip
If an accounts date is chosen where overlap profits will arise, it may make sense to try and ensure that such overlap profits are mitigated; for example, any highly profitable work, if possible, should be undertaken after the accounts date falling in the third tax year i.e. outside any overlap periods (assuming John’s accounts date is 30th April 2009 any highly profitable work should be pushed into the period commencing 1st May 2010).
By Malcolm Finney
