Could changing your accounting date help reduce your tax bill?
If you’re an unincorporated business (a sole trader or partnership), you have free choice when it comes to your accounting date says James Dawson. Some choose a date for commercial reasons – for example to fit in with a cyclical trading pattern or to fall in a slack period – and for others the logical choice may be 5 April (or 31 March) to align with the tax year.
Choosing the right year end will not only make life administratively easier for a business, but choosing a year end other than 5 April (or 31 March) can also give you a cash-flow advantage and create outright tax savings, if the circumstances are right.
Depending on the choice of accounting date, new businesses and individuals joining existing partnerships may see some of their profits taxed twice because of special rules which dictate when – and to what extent – business profits are assessed. Profits taxed twice are known as “overlap profits”.
Businesses trading when self-assessment was introduced in 1996/97 may be carrying overlap profits and changing a business’ accounting date can also cause profits to be doubly assessed.
The value of any doubly assessed or overlap profits is subsequently carried forward and given as a tax-reducer when a business ceases, when an individual leaves a partnership and on certain changes of accounting date.
The thought of profits being taxed twice naturally gives rise to a common misconception that overlap profits are bad. In reality, a change of accounting date can be used to your advantage, which is illustrated in the very simple case study below.
A partnership with a 30 April year end went from being highly profitable to being loss making, almost overnight. A 30 April year end is great, as it allows a lengthy period between making profits and paying tax on them, but, where a business falters as above, tax becomes payable when the business has no cash (unless it has a very prudent and very disciplined tax provision policy). In this case, changing the year end to 31 March enabled the partners to use their significant overlap profits and it also enabled earlier access to trading losses; this not only created significant cash-flow benefits for the business, but it also got rid of the overlap profits.
A few years later, the business returned to significant profitability, almost as spectacularly as it became loss making, resulting in significant tax bills made worse by the catch-up effect of a large self-assessment balancing payment plus payments on account. In the light of this, the partnership year end was returned to 30 April, which created some new overlap profits, but it also had two additional and significant benefits:
It deferred payment of significant amounts of tax by 12 months, creating positive cash flow and allowing the business to get its tax provisioning in check; and
- It pushed profits into a later tax year, giving the opportunity to undertake some income tax planning and reduce the deferred tax liabilities.
So if you’re unincorporated and interested in finding out more about this specific issue of your accounting date, it’s certainly worth starting a conversation with your accountant.