TXF6 UK
Syllabus B. Income Tax And Nic Liabilities B3. Income from self-employment

B3f. Assessable profits on commencement 6 / 11

Syllabus B3f)

Compute the assessable profits on commencement

Step 1: The first tax year (TY1)

The first tax year is the year during which the trade commences. 

For example:
if a trade commences on 1 June 2020 the first tax year is 2020/21 (06/04/2020 – 05/04/2021)

The basis period for the first tax year runs from the date the trade starts to the next 5 April.

So a trader commencing in business on 1 June 2020 will be taxed on profits arising from 1 June 2020 to 5 April 2021 in 2020/21.

Step 2: The second tax year (TY2)

Does the accounting date fall in Tax Y2?

  • YES

    How long is this accounting period?

    • < 12 months long                                                   

      Calculate profits for the first 12 months of trading

    • ≥ 12 months long    

      Calculate profits for the 12 months to the accounting date ending in Y2

  • NO

    • Assess the actual profits in tax year 2

       i.e 6 April to 5 April

      For example if trade commenced on  01/01/2020 and accounts were prepared to 31/07/2021, the first tax year is 19/20 and the second tax year is 20/21 - but there is no accounting date ending in the second tax year.

      Therefore, profits from 06/04/2020-05/04/2021 will be taxed in the second tax year (20/21).

So, let's go back to our original example:

Assuming that the accounting date is 31 May 2020.

The second tax year (TY2) - 2021/22

  • Does the accounting date (31 May 2021) fall in Tax Y2 (2021/22)?

    YES

  • How long is this accounting period?

    1 June 2020 - 31 May 2021

    ≥ 12 months long

    Therefore, calculate profits for the 12 months to the accounting date ending in TY2:

    1 June 2020 - 31 May 2021

Step 3: The third tax year (TY3)

  • Use a current 12 months accounting period

So, let's go back to our example (assuming they continue to make accounts up to 31 May each year):

  • The third tax year (TY3) - 2022/23:

    1 June 2021 - 31 May 2022

Step 4: Comment on Overlap profits

If the same profits have been taxed two times, at the end of the question, mention how much profit has been taxed 2 times. 

For example if a business commenced trading on 01/01/2020, prepared accounts to 31/12/2020 and made a trading profit of £12,000 during the 12 months.

The first tax year would be 19/20 (01/01/2020-05/04/2020) and 3 months of profit would be of £3,000 (3/12*£12,000) would be taxed.

The second tax year would be 20/21 and as the accounting period is 12 months long, the full £12,000 would be taxed.

Therefore, the £3,000 of 19/20 has been taxed 2 times, this is the overlap profit.

You must mention this in your answer.

Illustration 1 - ≥ 12 months long

Peter starts to trade on 1 January 2020 making up accounts to 31 March 2021.

He made profit of £15,000 for the year ended 31/3/2021
He made profit of £24,000 for the year ended 31/3/2022

  1. The first tax year (TY1 = 2019/20)

    1/1/2020 - 5/4/2020

    Profit = £15,000 x 3/15 = £3,000

  2. The second tax year TY2 =  2020/21 (06/04/2020 – 05/04/2021)

    Does the accounting date (31/3/2021) end in TY2?

    YES
    How long is this accounting period?

    ≥ 12 months long 1/1/2020 - 31/3/2021

    Calculate profits for the 12 months to the accounting date ending in Y2 1/4/2020 - 31/3/2021.

    Profit = £15,000 x 12/15 = £12,000

  3. The third tax year (TY3 = 2021/22)

    Use the current 12 months accounting period
    1/4/2021 - 31/3/2022

    Profit = £24,000

  4. Comment on Overlap profits

    Trading profits £15,000 + £24,000 = £39,000

    Less profits assessed (£3,000 + £12,000 + £24,000) = (£39,000)

    Overlap profits £Nil

Illustration 2 - < 12 months long

Draco commences business on 01/01/2020.

He prepares his accounts to 31/07

  • Below are the trading profits for the accounting periods:

    £10,500 for the 7 months to 31/07/2020

    £33,600 for the year ended 31/07/2021

  • What trading profits will be assessed for  19/20, 20/21 and 21/22?

Solution:

  1. The first tax year (TY1 = 2019/20)

    1/1/2020 - 5/4/2020

    Profits 3/7 * £10,500 = £4,500

  2. The second tax year TY2 =  2020/21 (06/04/2020 – 05/04/2021)

    Does the accounting date (31/7/2020) end in TY2?

    YES

    How long is this accounting period? (1/1/2020 - 31/7/2020)

    < 12 months long

    Calculate profits for the first 12 months of trading - 01/01/2020 - 31/12/2020

    Profits £10,500 + (5/12 * £33,600) = £24,500

  3. The third tax year (TY3 = 2021/22)

    Use the current 12 months accounting period:
    01/08/2020 - 31/07/2021

    Profits £33,600

  4. Overlap profits

    Trading profits £10,500 + £33,600 =  £44,100

    Less profits assessed (£4,500 + £24,500 + £33,600) = (£62,600)

    Overlap profits £18,500

Illustration 3 - when the accounting date doesn't fall in Tax Y2

Lachmi commenced self employment on 01/01/2019.

She had a profit of £10,000 for the period ending 30/04/2020.

Calculate the tax adjusted trading profit for the period ended 30/04/2020.

Solution

  1. The first tax year (TY1 = 2018/19)

    Assessed period 01/01/19 - 05/04/19 = 3/16 * £10,000 = £1,875

  2. The second tax year TY2 = 2019/20 (06/04/2019 – 05/04/2020)

    Does the accounting date (30/4/2020) end in TY2?

    NO

    Therefore, profit will be calculated as follows:

    Assessed period  06/04/19 - 05/04/20 = £10,000 * 12/16 = £7,500

  3. The third tax year (TY3 = 2020/21)

    Does the accounting date (30/4/2020) end in TY3? 
    YES

    How long is this accounting period? (1/1/2019 - 30/4/2020)

    > 12 months long therefore tax the last 12 months of the long period

    01/05/19 - 30/04/20 = £10,000  * 12/16 = £7,500

  4. Overlap profits

    Overlap profits created: £1,875 + £7,500 + £7,500 - £10,000 = £6,875