Year-End Tax Planning:
Changing Accounting Date
Save thousands with careful tax planning
Most businesses are free to change their accounting date at least once every six years. This means they will either be shortening an accounting period, or extending it. The maximum permitted length for an accounting period is generally eighteen months.
For a private company, the procedure is relatively simple: submit a completed Form AA01 to Companies House any time before the original filing date for the accounts in question.
For example, if your current accounting date is 31st December, but you want to draw up accounts for the fifteen-month period ending 31st March 2010, you have until 30th September 2010 to advise Companies House. You can shorten your accounting period using a similar procedure.
Changing your accounting date may sometimes have the added benefit of deferring your Companies House filing deadline, as your new deadline will usually be the later of the date falling nine months from your new accounting date, or three months from the date you submitted Form AA01.
Extending your accounting period may save Corporation Tax if your company’s profits are falling.
Agyeman Limited made profits of £400,000 in the year ended 31st December 2009 but just £50,000 in the following six months.
As things stand, £100,000 of the company’s 2009 profits will suffer Corporation Tax at a marginal rate of 29.75%.
Instead, the company draws up accounts for the eighteen months ending 30th June 2010. For Corporation Tax purposes, this is divided into two periods: the twelve months to 31st December 2009 and the six months to 30th June 2010. The total profits of £450,000 for the eighteen month accounting period are allocated to the two Corporation Tax periods on a time-apportionment basis – i.e. £300,000 and £150,000.
None of the company’s profits now exceed the small companies rate threshold of £300,000, all of them are taxed at just 21%, and the company saves £8,750.
Note that the small companies rate threshold of £300,000 is also time-apportioned. The threshold for the six month period ending 30th June 2010 is therefore just £150,000.
For rising profits, a partial deferral of Corporation Tax may be achieved by shortening your company’s accounting period.
Amibovvered Limited made profits of just £250,000 during the nine months ended 31st December 2009. After that, however, it starting making profits of £100,000 per month.
This will push the company’s profits for the year ending 31st March 2010 up to £550,000, giving the company a Corporation Tax bill of £137,375 payable by 1st January 2011.
Instead, the company draws up accounts for the nine months ended 31st December 2009. These give rise to a Corporation Tax bill of just £54,687, although this will be due on 1st October 2010. However, the tax on the greater profits arising from January 2010 onwards will not be due for another twelve months.
It’s even easier for sole traders to change their accounting date, as they don’t need to tell Companies House. The consequences of the change can be much more complex, however – but extremely beneficial in some cases.
The sole trader simply draws up accounts to their new accounting date and puts this date on their Tax Return. For the new date to be effective for tax purposes the Tax Return must be submitted on time and the new accounting period must not exceed eighteen months. Unless the change is made for commercial reasons, there must not have been another earlier change in the previous five tax years.
Your taxable profit for the year in which the change takes place depends on the length of your accounting period and on when your new accounting date falls.
If you’ve shortened your accounting period, you will have either one or two accounting dates falling in the tax year. If just one accounting date falls in the tax year, you will be taxed on your profits for the period of twelve months ending on your new accounting date. This means that part of your profits for the previous accounting period will be taxed twice. Any profit which is taxed twice is known as an ‘overlap profit’. This also frequently occurs when you start a new business.
Relief for your ‘overlap profit’ is given when you cease trading, or sometimes on a subsequent change of accounting date. We’ll come on to that in a minute.
It may seem like a bad idea to be taxed on the same profit twice, but sometimes you can generate future overlap relief, which could later save you tax at 42% or even more, without paying any extra tax now.
Matt’s profits for the year ended 31st March 2009 were £12,000. His profits for the rest of 2009 fell to just £300 per month. Matt prepares accounts for the nine months ended 31st December 2009. His taxable profits for 2009/10 are:
Three months to 31st March 2009: 3/12 x £12,000 = £3,000
Nine months to 31st December 2009: 9 x £300 = £2,700
This is less than both the personal allowance and the national insurance earnings threshold. Matt has thus created an overlap of £3,000 available for future use with no current tax cost. If he’s a higher rate taxpayer when he ceases trading, this could save him £1,260.
If two accounting dates fall in the year, you will be taxed on the profits of both periods. This means you are taxed on more than twelve months of profit in one year, but it also means you may be eligible to claim overlap relief: more on that later.
Long Accounting Periods
If you extend your accounting period, you will either have one accounting date falling in the tax year or none. Where no accounting date falls in the current tax year, you will effectively be taxed on the same twelve months’ worth of profit both this year and next year, calculated on a time-apportionment basis.
Noel draws up accounts for the fifteen months ended 30th June 2010 showing a profit of £15,000. As no accounting date falls into 2009/10, he is taxed on a profit of £12,000 (£15,000 x 12/15). Noel is taxed on the same sum in 2010/11, thus creating an ‘overlap profit’ of £9,000 (2 x £12,000 - £15,000).
Unlike Matt, Noel’s overlap profit comes at a price: basic rate tax and national insurance totalling £1,608 in each year. But Noel would probably have paid that amount anyway. Furthermore, he has the benefit that tax on profits arising between July and March will now always be deferred by a year and he has potential overlap relief worth £3,780 (£9,000 x 42%), or even more, to claim in the future.
Using Overlap Relief Now
If you extend your accounting period but your new accounting date still falls in the same tax year, you are taxed on the profits of the whole period. As this is more than twelve months, you can claim relief for some or all of any overlap profit which arose in the past.
Most people whose existing accounting date is not 31st March or 5th April will have overlap profits from when they started trading or from when the self-assessment system began in 1997. You can find your overlap profit in Box 69 on the self-employment pages of your 2009 tax return. If there’s nothing there check with your accountant: many of them neglect to complete this box as it only affects future periods.
The overlap relief available on a change of accounting date is based on the length of the extended accounting period in excess of twelve months as a proportion of the original period of overlap (but the relief cannot exceed the total amount of overlap profit available).
This means that extending your accounting period to a date falling later in the same tax year will be beneficial whenever your profits have fallen below their original level at the time that the overlap was created.
Catherine has overlap profits brought forward of £36,000 due to a previous overlap period of nine months. She therefore has overlap profits of £4,000 per month.
Her profits have now fallen to just £2,000 per month, so Catherine decides to draw up accounts for the eighteen months ended 31st October 2009. Her taxable profit for 2009/10 is:
Profit for period ended 31/10/2009: 18 x £2,000 = £36,000
Less overlap relief for period in excess of 12 months
6/9 x £36,000 £24,000
Taxable profit: £12,000
If Catherine had stuck to her usual accounting date, her taxable profit would have been £24,000 (12 x £2,000). The change of accounting date has halved her taxable profit, saving her £3,360 in income tax (at 20%) and national insurance (at 8%).
The only drawback here is that Catherine has effectively ‘cashed in’ some of her overlap relief at an effective rate of just 28%. This could be disadvantageous if her marginal tax rate is higher when she eventually ceases trading. On the other hand, that could be many years away and inflation may have severely eroded the value of her overlap profits by then: a bird in the hand is worth two in the bush!
Partnerships can generally change their accounting date in much the same way as sole traders.
The impact on each partner will differ, however, as each will have their own individual overlap profit and marginal tax rate. The same change of accounting date could be beneficial for one partner, but disastrous for another.
Limited Liability Partnerships which change their accounting date need to advise Companies House using form LL AA01 and are subject to the same deadlines as a company.
Individuals are taxed on rental profits on a ‘tax year’ basis, regardless of their accounting period, so changes of accounting date don’t have the same affect. There is, however, still lots that can be done!