When you are self employed you pay tax on your business profits according to the tax year (6th April to 5th April) you make those profits rather than your accounting period. A tricky situation can arise if you are newly self employed and choose an accounting period that is different to the tax year meaning you can end up paying tax twice on the same profits in the first two years of your business – this duplicate profit is referred to as your Overlap Profit.
Overlap profits occur mainly when someone who is self employed choose an accounting period that is not the same as the tax year because HMRC sets out rules as to which months you must include your income & expenses for on your tax return (this is called the basis period).
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.
Karan therefore will have to calculate her tax and national insurance on her overlap profits of £10,126 (308 days / 365 days x £12,000) 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.
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