Choosing the right date for an accounting year-end may help a business with taxation and cash flow issues.
The tax year runs from 6 April to 5 April and most businesses use the tax year for their accounting year too, although it may be more convenient to use 31 March (known as ‘fiscal accounting’) as the end date for the business year.
As a general rule of thumb, the earlier in the tax year you select as your accounting year-end, the longer you will have to pay tax on your profits. As a result:
· where your profits are increasing, your tax bill will rise more slowly; and
· where your profits are falling, it will take longer for any reduction in your tax bill to take effect. However, if your profits are falling you could consider changing your accounting date to later in the year.
Starting up the business
Choosing a different date may give the business owner longer to file his or her tax return and longer to pay the tax due. However, choosing a different year-end date has one big drawback – it means that the taxpayer will pay tax twice on the same profits in the first two years of trading. This is because the basis periods for calculating income tax are different in the first two years of trading:
· First year of trading - Tax liability is based on profits from the date trading started to the following 5 April – even if this isn’t the chosen business year-end. Therefore, the first tax bill can cover just a few days (if the business commenced on, say, 25 March), or nearly a full year (if it commenced on say, 20 April).
· Second year of trading - Tax liability is usually based on the 12 months of trading that ends on the chosen year-end date. However, if the chosen a year-end date is less than 12 months after the start of the business, the tax liability is based on the first 12 months of trading.
From the third year onwards, tax liability is calculated using the business accounts for the 12 months ending in the tax year to which the self-assessment return relates. So, if a trader draws his accounts up to 30 June each year, his tax bill for 2014–15 will be based on the accounts for the 12 months ending on 30 June 2014.
Example – Basis of assessment: starting a business
James started his business on 1 September 2012 and prepares his accounts to 30 April, starting with an eight-month period of account to 30 April 2013. His profits for the first three accounting periods are as follows:
8 months to 30 April 2013 £24,000
Year to 30 April 2014 £39,000
Year to 30 April 2015 £40,000
His taxable profits for the first four tax years are as follows:
Tax year Basis period Taxable Profits
2012-13 1.9.12 to 5.4.13 £24,000 x 7/8 £21,000
2013–14 1.9.12 to 31.8.13:
1.9.12 to 30.4.13 £24,000 +
1.5.13 to 31.8.13 (£39,000 x 4/12) £13,000 £37,000
2014–15 Y/e 30.4.14 £39,000
2015–16 Y/e 30.4.15 £40,000
Effectively, James will have been taxed twice on profits for the period 1 September 2012 to 5 April 2013 (i.e. a 7-month period, totalling £21,000), and from 1 May 2013 to 31 August 2013 (4-month period, totalling £13,000).
When James stops trading, he can deduct the whole amount of overlap profit (£34,000) from his taxable profit figure for his last year of trading. Although this deduction helps reduce his tax liability for his final year of trading, it may be many years before he can claim it, and when he does, his overpayments will not be adjusted for inflation or changing tax rates.
Practical Tip:
Costs in the first few years of trading are often greater than income. The overlap rules won’t be an issue at that stage because there will be no profits on which to pay tax. However, for most small businesses, overlap is something to be avoided, and this can be done simply by aligning the business year-end with the tax year.
