What are Overlap Profits? Falling victim to overlap profits can mean you end up paying tax twice on your first period of trading profits. Here’s more about overlap profits, examples of how they arise and the implications.
HMRC have strict rules you need to follow when you are self-employed, but they can be confusing and make you worry whether you are going to get hit with a huge tax bill. Overlap profits definitely fall into this category!
Here’s more about overlap profits, how they work and how you can avoid ending up with an unnecessarily large tax bill.
What are Overlap Profits
Overlap profits occur mainly when someone who is self-employed chooses an accounting period that is not the same as the HMRC basis period.
The HMRC basis period, generally just means the tax year (6 April to 5 April each year).
Put simply a basis period is the time that HMRC sets out that everyone must report on for taxes, but an accounting period is something you can choose and can be any date you like.
When the basis period and accounting period are not the same, overlap profits can arise.
It is common for the newly self-employed completing their self-assessment tax return to be affected by overlap profits and put themselves at risk of paying a larger than necessary amount of tax.
Overlap Profits Example 1
You go self-employed and start trading on 1 July 2018, choosing an accounting period of 30 June each year.
Here are your basis periods for the first three tax years of trading, starting tax year 2018/2019.
|Tax Year||Basis Period|
|2018/2019||1 July 2018 to 5 April 2019|
|2019/2020||1 July 2018 to 30 June 2019|
|2020/2021||1 July 2019 to 30 June 2020|
You’ll need to include your income and expenses for each basis period on each of the tax returns.
You will notice that the period 1 July 2018 to 5 April 2019 is reported twice – this is your overlap profit.
It means you are going to pay tax twice on those profits in tax year 2018/2019 and 2019/2020.
Overlap Profits Example 2
Following on from the above, you have been self-employed for some years now with your accounting period ending 30 June each year.
In the tax year 2021/2022 you decide to lengthen your accounting period to 30 September.
Your basis period for 2020/2021 was 1 July 2019 to 30 June 2020, but your new one for 2021/2022 will be 15 months long (1 July 2019 to 30 September 2021).
That means there are overlap profits for the period 1 July 2019 to 30 June 2020.
If your accounting period in the tax year before you make the change is more than 12 months after the end of the basis period for the previous tax year, your basis period is the period between the end of the basis period for the previous tax year and the new accounting date.
Overlap Profits Example 3
Following on from example 1, you have been self-employed for some years now with your accounting period ending 30 June each year.
In the tax year 2021/2022 you decide to shorten your accounting period to 31 May.
Your basis period for 2020/2021 was 1 July 2019 to 30 June 2020, but your new one for 2021/2022 will be 1 June 2020 to 30 May 2021.
Overlap profits will be for one month – June 2020.
If your new accounting date is less than 12 months after the end of the basis period for the previous tax year, your basis period is the 12 months ending on the new accounting date.
Can You Just Change Accounting Date?
Whilst you don’t have to ask HMRCs permission to change your accounting date, there are some rules you need to follow:
- you must tell HMRC about the change in your tax return;
- the first accounts for the new accounting date, must not be more than 18 months
- if you changed accounting date in any of the previous 5 tax years, you must tell us why you’ve made the change – you can’t switch to get a tax advantage, any changes must for genuine business reasons.
How to Avoid Overlap Profits
The simplest way to avoid overlap profits when you’re self-employed is to choose an accounting period that matches the tax year. So thats an accounting period that ends:
- 5 April or;
- 31 March.
Overlap relief is a type of tax relief for any double taxation paid on overlap profits.
HMRC permits tax relief for overlap profits to be used:
- When changing accounting periods;
- On cessation of trade either by stopping the business or incorporating it.
That way, a business will have paid the right amount of tax across the time it is in existence.
Updated: 27 May 2019
Anita is a Chartered Accountant with over a decade of experience taking self employed business owners from financially confused to business savvy.
She is the creator of the ‘Go Self Employed’ website, which her corner on the internet where she makes self employment less terrifying.