Accounting dates for sole traders
When you start in business as a sole trader, or in partnership, your first accounting period starts the day your business commences. Your accounting ends on the date to which your accounts are prepared. This post discusses the choice of accounting dates for sole traders or partnerships and the tax implications.
The standard practice is to prepare accounting dates for sole traders that cover a 12 month period. Though it may be that your first accounting period is longer or shorter than this.
The choice of accounting dates for sole traders and partnerships ultimately determines their basis period for tax purposes.
What is a basis period?
The basis period is the time period for which a sole trader or partnership pays tax each year. Usually the basis period for your business will be the same as its accounting year. Each individual in a partnership has their own basis period. Basis periods apply to individuals and not to the partnership as a whole.
There are special rules that apply for the opening years of your trade or profession. Generally speaking the rules for determining basis periods in the opening years are as follows:
The majority of sole traders and partnerships tend to choose a period or year end that finishes at month end. It may be more convenient to ensure that your accounting period matches that of the tax year.
What are overlap profits?
Overlap profits are profits which have been taxed twice under Self Assessment. They arise either during the opening years of your business or when you change your accounting date.
It's important to notify HM Revenue of your overlap profits on your tax return each year. This is because you can deduct overlap profits either when you change your accounting date or your business ceases.
Choice of accounting date
If the profits from your business are likely to start high and then decrease you'll want to avoid overlap profits. This is because they would potentially be taxed twice in your opening years at a higher level. So in this case it would be more advantageous to have a 31 March accounting year end.
Conversely if you profits are likely to increase you might obtain a cash flow advantage by selecting a year end which give you overlap profits - for example the 30 April. As a result profits will be taxed at a lower level and tax liabilities on higher profits will be deferred until later tax years.
Cory starts his business on 4 July 2019 he prepares his accounts to 31 March 2020.
Paul starts his business on 1 July 2019 he prepares his accounts to 30 June 2020.
Changing your accounting date
You might consider changing your accounting period. This could be advantageous if there is a change of income tax rates. You could also accelerate or decelerate the timing of your profits being charged to tax.
If your accounting period ends on a date which is not the end of the tax year you could have overlap profits (see above). These can potentially be deducted from any future profits. This might be to your advantage if you have high overlap profits.
Details relating to changing your accounting date are set out here in HM Revenue's guidance, though the key conditions are as follows:
What about losses in opening years?
You will need to determine which period ending is the most effective. It could be that having a 31 March or 5 April year end will enable you to obtain relief for the loss sooner rather than later. Conversely having an accounting period that straddles a tax year might result in higher tax relief overall.
It is also important to mention that relief for losses can only be given once. It is therefore not possible to create 'overlap losses'
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