Choosing an accounting date

In this post we'll cover choosing an accounting date if you're a sole trader or partner. If you're limited company changing your accounting date you can find more details here.

Choosing an accounting date

You can choose any accounting date for your business. Normally you are taxed on whatever accounting date ends in the relevant tax year. For example, the year end 30th June 2020 ends in the 2020/21 tax year and the year end 31st March 2020 ends in the 2019/20 tax year. 

However, there are a number of factors to consider when choosing an accounting date. We’ve therefore highlighted these below:

Overlap profits

The taxman aims to tax your profits in full over the lifetime of your business. However unless your accounting date falls between 31 March and 5 April (inclusive) there will always be some element of double counting. This double counting is known as  ‘overlap profits’.

These occur in the first full tax year your profits are taxed on the current year basis. This is because a sole trader business or partnership is taxed slightly differently in the first year of its trade than in subsequent years. They can also potentially arise if you decide to change you accounting date in a later tax year.

The easiest way to demonstrate this is, is to show you an example:

An example

Jim prepares his first business accounts for the year ended 30 April 2020 and the profits are £30,000. He will be taxed as follows:

  • 'Actual' profits for the period 1 May 2019 to 5 April 2020. These fall within the 2019/20 tax year. Therefore 309/365 x £30,000 = £25,397 taxable profits
  • Profits for the twelve month period ending in the following tax year  - 2020/21. Therefore profits for the year ended 30 April 2020

As you can see above the profits of £25,397 for the period 1 May 2019 to 5 April 2020 are actually taxed twice in the 2019/20 and 2020/21 tax years. This is the reason why they are known as ‘overlap profits’.

These ‘overlap profits’ can be deducted from your profits either when you cease your business (see below) or when you change your accounting date at a later stage. 

However because of inflation, overlap relief is likely to be worth less to you, when you finally ‘bank it’ at a later stage.

Do you ever pay higher profits in your final year's trading?

Depending on your accounting year end date you could end up paying tax on more than 12 months’ worth of profits when you cease the business. 

This is because you are taxed in your final year on the profits right back to the start of your final accounting date – this could be in a previous tax year. 

For example the accounting year ended 30 April 2020 straddles two tax years – the year ended 5 April 2020 and 5 April 2021. Let’s see how this works in practice below. 

An example

You have been trading for many years and your accounting year end date is 30 April. You then decide to cease trading on 31 January 2021.

For the tax year 2020/21 you would have been taxed on the profits for the year ended 30 April 2020. For the 2021/22 tax year you would have been taxed on the profits for the year ended 30 April 2021.  However your business has ceased trading (see below).

Because your business ceased trading before the end of the 2020/21 tax year (remember it ceased on 31 January 2021), you are taxed on the profits for the period 1 May 2019 to 31 January 2021.

In other words, you are taxed on 21 months instead of 12 months! Although ‘overlap profits’ can be deducted from these profits, the benefit of this deduction could have been eroded over time.

It’s therefore important, to think carefully when choosing an accounting date. Firstly when you start in business and secondly when you cease to trade.

Changing your accounting date

Once you’ve been trading for at least three years, you can then change your accounting date in the fourth year or later. 

In order for HM Revenue to approve the change you'll need to meet three principle conditions: 

  • The first accounts prepared to the new date must not be in excess of 18 months.
  • HM Revenue must be notified of the change by 31 January following the tax year of change. For practical purposes this is usually done via a Self Assessment tax return. For example a change of accounting date in the 2019/20 tax year would need to be notified by 31 January 2021.
  • There has been no earlier change of accounting date in the previous five years.The only exception being where a change has been made for a commercial reason. Obtaining a tax advantage is not one of them!

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].

Alternatively, please feel free to complete our Business Questionnaire here.

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