Overlap profits affect sole traders who choose to report income and expenses on their tax return using a different accounting period from the tax year. When this happens HMRC invokes the rules of basis periods meaning sole traders can be taxed twice on a portion of their business profits.
In this guide, I’ll use examples to show you how overlap profits arise and how overlap relief can be claimed to get the overpaid tax back.
Table of contents
I’ve updated this post on 20 January 2021
1. What are Overlap Profits?
Overlap profits usually occur when a sole trader chooses an accounting period that is not the same as the HMRC basis period. It most commonly arises for individuals who have just become self-employed and are filling out their first tax return. The easiest way to explain is using an example.
1.1 Example of Overlap Profits #1
|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 returned for 2018/2019 and 2019/2020 meaning tax is paid twice because will be included in two separate tax returns.
Following on from the above, the sole trader has now been trading for some years and decides to change accounting periods. 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 end date.
1.2 Example of Overlap Profits #2
Following on from the first example instead of lengthening accounting periods, the sole trader decides to shorten their accounting period to 31 May. 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. The result is that there will be overlap profits will be for the month of 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.
2. 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.
3. 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;
- Stopping self-employment, including if that is due to forming a Limited Company.
It means that they will have paid the right amount of tax across the whole time they are self-employed.
4. 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;
- 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.
4.1 Example of Overlap Relief
A self-employed business owner has an accounting period end date of 31 May each year and started trading on 1 June 2014. Here’s 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 and they paid tax accordingly. In the tax year 2017/2018, they decide to change accounting period from 31 May to 30 November. 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, so they can claim overlap relief of £6,016 (£10,126 * (183÷308)).
4.2 How to Claim Overlap Relief
Overlap relief is one of HMRCs income tax allowances and reliefs that can be claimed on your tax return in the year the claim is made. In the example above, 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 stopping self-employment so that across the life of a business the amount of taxable profits exactly matches the number of days a person has traded for.
Following on from the example above, there are remaining overlap profits of £4,109 and the final amount of overlap relief can be claimed on the final self-employment filed with HMRC. The amount of £4,109 can be set against the final profits declared to HMRC