By Clare Kendall, Business Owner & Bookkeeper, CLK Books
This blog talks about transitional profits, overlap relief and spreading profits for the transitional tax year 2023-24, an issue which arises under Making Tax Digital for Income Tax Self Assesment (MTD ITSA). If that means absolutely nothing to you, watch these previous videos to get up to speed:
If your accounting year ends between 31st March and 5th of April, you can stop reading as this won't affect you at all. If you have a different accounting year end date, you will be affected by what HMRC call the transitional year; 6th April 2023 - 5th April 2024. In this year you could have to report more than a year's profits on a single tax return.
For example, let's say your accounting year ends on 30th June. In this current tax year (6th April 2022 - 5th April 2023) you are going to report profits for 1st July 2021 - 30th June 2022 on your tax return. The following year is the transitional year so you will report profits for 12 months (1st July 2022 - 30th June 2023) plus the "transitional period" up to the 5th April 2024 to get you ready for the new rules that start on the 6th of April, 2024.
Example:
Jane Brown Plumbing has:
If this were to all be taxed in one year it would look something like this:
Tax estimate (income tax only):
£35,000 + £25,000 = £60,000
less £12,570 (personal allowance) = £47,430 taxable profits, taxed as:
- Basic Rate Tax on £37,700 @ 20% +
- Higher Rate Tax on £9,730 @ 40% = £11,432*
*Disclaimer : this is a very basic tax calculation, not taking national insurance or any other income sources into account.
Overlap Relief is deducting profit that you have already been taxed on twice. If you didn't start your business on the 6th of April it's likely that you will have reported the period from the start date of your business up until the following 5th of April twice - once on each of your first two tax returns. You will also have paid the tax on them twice and that money should be waiting on your tax return for when you close your business or change accounting dates, ready to be deducted from your trading profits.
To find it you will need to look at your submitted tax returns. You are looking for the self-employment pages to say "Self-employment (full)" at the top right. If it doesn't say full on your last tax return, go back historically until the last one that does. If you don't find one, you (or your agent) will have to contact HMRC.
You're looking for an entry in box 70: "Overlap profit carried forward" (on page 4 of the self-employment pages). The figure here is available to deduct from your trading profits before calculating tax.
Let's assume it has £10,000 in box 70 for the sake of the exmaple, then your tax calculation would look like this:
Tax estimate (income tax only):
£35,000 + £25,000 = £60,000
less £10,000 (overlap relief) = £50,000
less £12,570 (personal allowance) = £37,430 taxable profits, taxed as:
- Basic Rate Tax on £37,430 @ 20% = £7,486
HMRC will allow you to spread those transitional profits equally over five tax years from 2023-2024 to 2027-2028. This means on 1/5 of the profit is taxed in the current year.
In our example tax calculation this means the transitional profits are £3,000 per year instead of £15,000 in one year:
Tax estimate (income tax only):
£35,000 + £25,000 = £60,000
less £10,000 (overlap relief) = £50,000
less 4/5 of transitional profit (4 x £3,000 = £12,000) = £38,000
less £12,570 (personal allowance) = £25,430 taxable profits, taxed as:
- Basic Rate Tax on £25,430 @ 20% = £5,086
NB: If you're an existing client and this affects you, don't worry, I already have your overlap relief figures.
For Reference:
An overview of Making Tax Digital on GOV.UK
Open Consultation: Tertiary legislation for Making Tax Digital for Income Tax