The tax year runs from 6 April to 5 April and most businesses use this system for their accounting year too, although some people may find it convenient to use 31 March as the end date for their business year. This is also known as opting for fiscal accounting, so-called because the business year is the same as the tax, or fiscal, year.
Although the fiscal year is the most popular choice, it is possible to choose any other date for a business year-end. Choosing a different date can give a longer time to file self-assessment tax returns and longer to pay the tax due. Choosing a different year-end date does, however, have one major drawback – in the first two years of trading, the business will pay tax twice on the same profits. In the first year of trading, tax is calculated based on profits (assuming there are some!) from the date trading started to the following 5 April (even if this isn’t the chosen year-end date). So, the first year’s tax bill could cover just a few days (if trading commenced on say, 25 March), or nearly a full year (if trading commenced on say, 20 April).
In the second year, the tax bill will usually be based on the twelve months of trading that ended on the chosen year-end date. However, if you choose a year-end date that is less than 12 months after the start of your business, your tax bill is based on your first 12 months of trading.
From the third year onwards, your tax bill is calculated using your accounts for the 12 months ending in the tax year to which the self-assessment return relates. So, if for example, you draw your accounts up to 30 June each year, your tax bill for 2011–12 will be based on your accounts for the 12 months ending on 30 June 2011.
James started his business on 1 August 2010 and produces his accounts to 5 April 2011, that is, to the end of the fiscal year, and annually thereafter. James’s tax bill is based on the following profits:
Tax year Accounting period Taxable profits
2010-11 1 August 2010 to 5 April 2011 £8,000
2011–12 6 April 2011 to 5 April 2012 £18,000
2012–13 6 April 2012 to 5 April 2013 £24,000
2013–14 6 April 2013 to 5 April 2014 £30,000
Matthew also started a business on 1 August 2010 but he produces accounts to 31 July 2011, that is, for a period of 12 months, and annually thereafter. His profits for the 12 months to 31 July 2011 show a profit of £14,000. Matthew’s tax bill is based on the following profits:
Tax year Accounting period Taxable profits
2010–11 1 August 2010 to 5 April 2011 £9,512 (248/365 days x £14,000)
2011–12 1 August 2010 to 31 July 2011 £14,000
2012–13 1 August 2011 to 31 July 2012 £20,000
2013–14 1 August 2012 to 31 July 2013 £26,000
The period from the date Matthew started trading on 1 August 2010 to 5 April 2011 is taxed both for 2010–11 and 2011–12. This period is called the overlap period, and the amount that has been taxed twice (£9,512) is called the overlap profit. Effectively, Matthew pays tax on profits he hasn’t yet made. When Matthew stops trading, he can deduct the whole amount of overlap profit from his taxable profit figure for his last year of trading. Although this deduction will help reduce his tax bill for his final year of trading, it may be many years before he can claim it, and when he does his overpayments aren’t adjusted for inflation or changing tax rates.
If business costs in the first few years of trading are likely to be greater than income, the overlap rules will not be an issue, because there will be no taxable business profits and consequently, no tax to pay. But for most small businesses, overlap is something to be avoided, and this can be done by aligning the business year-end with the tax year.
It is possible to change your accounting year-end during the life of your business to lessen the effect of the overlap rules if you need to, although you should be aware that some restrictions apply. You can elect for a year-end change by notifying HMRC in writing in a letter or on a self-assessment form.
If you have to borrow money because paying tax on overlap profits means you have to take cash out of your business, you can claim tax relief on any loan interest you pay against future tax bills.
This article was first printed in Tax Insider in January 2012.