OVERLAP RELIEF
HOW OVERLAP RELIEF IS WORTH MONEY TO YOU
Overlap relief is about 12 years old now . When self assessment was introduced the Inland Revenue took advantage of changing what was known as the preceding year basis of assessment to an actual basis.
Under the former system there were tax planning opportunities to minimise tax payable by planning starting and finishing years of a self employed business and reducing the tax liability .
To stop this lawful practice the new system was intended to ensure that the profits assessed over the lifetime of a self employed business would be equal to the total assessments of the business
Originally it was planned that every busnesses year end would end on 5th April and the basis of assessment would be on actual imitating the PAYE system
This proved impractical as businesses can and do start on any one of the 365/66 days of the year
The new rules introduced and which exist today are
1 The basis year of assessment depends on when the business year end is ( a year end is 12 months from commencement and subsequent anniversay year ends) Thus a year end of 30th September 2009 falls in the government year of assessment 2009/2010. ( a shadow of the former preceding year basis)
The 1st year's basis of assessment is from commencement to next 5th April
The 2nd years basis of assessment is the first 12 months of the business or 6th April to 5th April with the year end changing to 5th April
The option gives some tax planning opportunities,as the rule for those whose basis of assessment stays on their aniversary date creates overlap relief as the same profits ( the 1st year are taxed twice and are allowed as a credit on cessation of the business)
OVERLAP RELIEF (POST 1997)
Example
Mr F. Christmas starts his business on December 6th 2006 making and selling toys
His Profits are
Year ended 5th December 2007 £120,000
Year ended 5th December 2008 £360,000
Year ended 5th December 2009 £600,000
His assessments for his business are as follows
1st year 2006/7 6.12.06-5.4.07 £40,000
2nd year 2007/2008 Option is available for 12 months or 5th April basis
A £ 120,000 y e 5.12.07
or B (6.12.07-5.4.08 )£80,000 +( 6.4.08 to 5.12.08) £120,000= £200,000
Option A is adopted so year end is 5th December
2008/2009 £360,000
2009/2010 £600,000
Overlap relief is £40,000 as this has been taxed in 2006/2007 and 2007/2008
Because the 12 month basis is used the first year has been taxed twice in 2 years of assessment so that overlap relief is granted amounting to £4,800
By choosing this option Mr Christmas has delayed his tax bill on £60,000 one year , thus improving his cash flow and has a credit against his closing profits when he retires of £48,000
TRANSITIONAL OVERLAP RELIEF
Because 1996/97 was the year when the the basis of assessment was changed from preceding to actual ( that is the traders year must finish in the year of assessment) self employed businesses, partnerships and sole traders, had 1 years profit credited as overlap relief . This amount is reported every year in the annual Tax Return
TAX PLANNING ON OVERLAP RELIEF
Relief is depreciated by inflation and the fact that when businesses ceases (apart from sale of business) the probable reason for termination is loss of profits and trading at a loss. Relief is not paid by HMRC as of right . The business MUST have made profits in the last period of trading against which relief can be set. Unless you plan for the credit there is a likelihood that you will lose the benefit of the credit of your money which was a double tax on your profits to the advantage of the public purse. Relief will also be affected by the changes in basic rate of tax .
In 1997 an amount of overlap relief of say £30,000 was worth at 22% basic rate £6600
In 2008 it was worth £6000 at 20% basic rate
Inflation has eroded it by 36.3% so that the real value is £19,110 at 20% The tax credit in real terms is £3,822 which is a depreciation of 63.7% in real terms.
If you have started a business recently and your year end is the anniversary of commencement you should develop a policy on action to be taken on your overlap relief
Readers should enquire of their accountants what the overlap relief policy should be.
We shall be happy to be appointed as new accountants to restructure your business to maximaize the overlap relief before it is worthless
Call 0845 263 4126 for a consultation