HMRC Overlap Relief

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HMRC Overlap Relief

Overlap profits occur mainly when someone who is newly self employed chooses an accounting period that is not the same as the tax year. Due to the rules of the HMRC tax system, a certain amount of a businesses profit can be picked up in two tax years.

An Example of Overlap Profits

Karan is a self employed candle maker and starts her business on the 1 June 2014 and decides to run her accounting period to the 31 May of each year. Her Basis Period for HMRC purposes and profit from her business for the next three tax years that need to be included in her tax returns are:

Tax Year Accounting Period Profits
2014/2015 1 June 2014 to 5 April 2015 £12,000
2015/2016 1 June 2014 to 31 May 2015 £15,000
2016/2017 1 June 2015 to 31 May 2016 £18,000

You’ll notice that due to the rules of the HMRC Basis Period Karan has has to include on her tax return and pay tax twice on her profits from 1 June 2014 to 5 April 2015 in the first two tax years of her business.  Unfortunately this is a common side effect of choosing an accounting period that does not match HMRC basis periods and the rules of how you work out your tax.  This duplication is what is known as Overlap Profits.

A portion of Karans profits are therefore subject to tax and national insurance in two different tax years. This is her overlap profits and amounts to £10,126 (308 days / 365 days x £12,000) being taxed in both the tax years 2014/2015 and 2015/2016.  This can be very expensive but unfortunately these are the rules, although there might be something she can do to get relief on this double tax called Overlap Relief.

Overlap Relief

There are two ways that HMRC sets out to gain relief for their overlap profits – changing accounting period or ceasing to trade.

Overlap Relief Change of Accounting Date

Overlap relief can be gained as a deduction against taxable profits if the accounting period for a business is changed so that the basis period for that tax year becomes longer than 12 months. However the amount of relief that can be claimed is restricted to:

  • the number of days in the overlap period(s) to which the overlap profits relate; and
  • the number of days by which the basis period for the relevant tax year (in which the change of accounting date occurs) exceeds 12 months.

Lets go back to our example above.

Karan decides to change her accounting period from 31 May to 30 November in the tax year 2017/2018. Here is a summary of all her basis periods for her tax returns:

Tax Year Accounting Period Profits
2014/2015 1 June 2014 to 5 April 2015 £12,000
2015/2016 1 June 2014 to 31 May 2015 £15,000
2016/2017 1 June 2015 to 31 May 2016 £18,000
2017/2018 1 June 2016 to 30 November 2017 (18 months) £25,000
2018/2019 1 December 2017 to 30 November 2018 £19,000

The overlap relief that Karan can claim in 2017/2018 is restricted because the basis period exceed 12 months by 183 days so we must restrict overlap relief by this amount.  Karan can claim relief of £6,016 (£10,126 * 183/308), which she can do on her tax return for 2017/2018 by setting this against her taxable profits. This leaves a remaining amount of overlap relief of £4,109 which she can use on cessation of her business.

Overlap Relief On Cessation

Any overlap relief not used can be claimed in the tax year that a business ceases trading.  Karan has remaining overlap profits of £4,109 so in her final tax return she submits for her business she can set this amount against her final profits.  This means across the life of her business the amount of chargeable profits exactly matches the number of days she has traded for.