I’ve updated this post on 26 May 2020
Overlap profits affect self-employed (sole trader) individuals who choose to report income and expenses on their tax return for a different period to the tax year.
When this happens sole traders can be taxed twice. They can claim the overpayment back using the rules of overlap relief but this requires changing accounting period or stopping self-employment.
In this guide, I’ll use some simple examples to show you how overlap profits arise and how overlap relief can be claimed to get the overpaid tax back.
What are Overlap Profits?
The normal HMRC basis period is the tax year, which is 6 April to 5 April each year.
To create fairness across everyone who is self-employed, HMRC taxes everyone on the same time-frame, regardless of the accounting period they choose.
When the basis period and accounting period are not the same, overlap profits can arise.
Overlap profits most commonly occur for anyone who is newly self-employed.
A person decides to go self-employed on 1 July 2018, choosing an accounting period of 30 June each year.
Here are the 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|
Profits for the period 1 July 2018 to 5 April 2019 are reported twice in the tax years 2019 and 2020. This is overlap profit and means tax is paid twice because it is included in two tax returns.
Following on from the above, the sole trader has been trading for some years and decides to change their accounting period.
In the tax year 2021/2022 they decide to lengthen their accounting period to 30 September.
The basis period for 2020/2021 was 1 July 2019 to 30 June 2020, but the 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.
Following on from example 1, the individual has been self-employed for some years now and decides to shorten their accounting period to 31 May each year.
The basis period for 2020/2021 was 1 July 2019 to 30 June 2020, but the new one for 2021/2022 will be 1 June 2020 to 30 May 2021.
Overlap profits will be for one month – June 2020.
If the new accounting date is less than 12 months after the end of the basis period for the previous tax year, the basis period is the 12 months ending on the new accounting date.
How to Change Accounting Date
Whilst you don’t have to ask HMRCs permission to change your accounting period, there are some rules you need to follow:
- HMRC must be notified of changes in the tax return;
- the first accounts for the new accounting date, must not be more than 18 months
- if a previous change in accounting date occurred in any of the previous 5 tax years, HMRC must be given a valid reason for the change. Changes can’t be made to get a tax advantage, any changes must for genuine business reasons.
How to Avoid Overlap Profit
The easiest way for the self-employed to avoid overlap profit is to choose an accounting period that matches the tax year.
So that’s an accounting period that ends:
- 5 April or;
- 31 March.
What is Overlap Relief?
Overlap relief is a type of tax relief for any double tax paid on overlap profits.
HMRC allows self-employed business owners to claim back this overpaid tax, using the rules of Overlap Relief when:
- Changing accounting periods;
- Ceasing trade either by stopping the business or incorporating it.
That way, they will have paid the right amount of tax across the whole time they are self-employed.
Overlap Relief on Changing of Accounting Periods
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.
A self-employed business owner has an accounting period end date of 31 May each year and started trading on 1 June 2014.
Here’ how the profits of each accounting period are taxed through self-assessment using after adjusting for basis periods:
|Tax Year||Basis 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|
Overlap profits occurred from 1 June 2014 to 5 April 2015.
They decide to change accounting period from 31 May to 30 November in the tax year 2017/2018.
The overlap relief that they can claim in 2017/2018 is restricted because the basis period exceeds 12 months by 183 days so overlap relief is restricted.
They can claim overlap relief of £6,016 (£10,126 * 183/308).
How to Claim Overlap Relief
This overlap relief can be claimed on their 2017/2018 tax return by setting this figure against taxable profits.
This leaves remaining of overlap relief of £4,109 which can be used on cessation of self-employment.
Overlap Relief On Cessation
Any overlap relief not used can be claimed in the tax year that a business ceases trading.
This means across the life of a business the amount of chargeable profits exactly matches the number of days she has traded for.
Following on from the example above, there are remaining overlap profits of £4,109.
This final amount can be claimed as overlap relief in the final self-employment sections filed with HMRC.
The amount of £4,109 can be set against the final profits declared to HMRC
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