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.

Choice of accounting dates for sole traders
For UK tax purposes, the tax year covers the period 6 April to 5 April. By concession HM Revenue accepts that an accounting period that ends any time between 31 March and 4 April is treated as running to 5 April. 
So for example a set of accounts prepared for the year ending 31 March 2020 is assessed identically to a set prepared to the year ending 5 April 2020.

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: 

  • 12 months of profits should be taxed wherever possible
  • No more than 12 months of profits should be taxed in a single year
  • At may be that some profits will be taxed in more than one year. These are known as overlap profits - see below

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. 

Example 1

Cory starts his business on 4 July 2019 he prepares his accounts to 31 March 2020.

  • His first accounts cover the period 4 July 2019 to 31 March 2020.
  • Cory's first accounts will show a profit or loss under Self Assessment for the 2019/20 tax year.
  • His second accounts will be prepared for the year ended 31 March 2021 and will be disclosed on his 2020/21 Self Assessment tax return.

Example 2

Paul starts his business on 1 July 2019 he prepares his accounts to 30 June 2020.

  • On his 2019/20 tax return he reports the proportion of profits that fall in the 2019/20 tax year. In other words he apportion his profits for the period 1 July 2019 to 5 April 2020. This equates to 280/365 (days) x the profits.
  • On his 2020/21 tax return he reports the profits from his first twelve months of trading so for the year ended 30 June 2020.
  • His profits for the period 1 July 2019 to 5 April 2020 are taxed twice. These are his overlap profits.

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:

  • You must notify HM Revenue by 31 January following the tax year in which the change is made. So for the 2019/20 tax year the deadline would be 31 January 2021
  • The new accounts must not be for a period longer than 18 months. This is where it all went wrong for 'Harry Potter' star Rupert Grint
  • You must not have had a previous change of accounting year-end in the last five years unless a genuine commercial reason now exists for the change

​​​​What about losses in opening years?

Loss relief may be restricted if HM Revenue consider that your business is a hobby If you are cash accounting you can only carry losses forward.

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'

For more useful information, check out our Ebooks here.

And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at [email protected].

Spread the word!

Why Friendly

We work with businesses and contractors/freelancers who want to embrace the world of online software and the benefits this brings. Using technology to help our clients is at the core of everything we do.

So if you'd like to find out more, just give a call or drop us an email - no hard sell.

Just friendly, professional advice!

Who we are

We're a small team with over 50 years experience of working with small businesses.

So we're in a unique position to understand the challenges that you face every day in your business.

And what's more, we're fully professionally qualified so you can be sure that your affairs are in safe hands.

Copyright 2016 by TFA Accountants Limited