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What is Overlap Profit?

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Overlap Profit affects Sole Traders and Partnerships, here are a couple of examples from BIM81080

Example 1 – one overlap period

A business commences on 1 October 2010. The first accounts are made up for the 12 months to 30 September 2011 and show a profit of £45,000.

The basis periods for the first three tax years are:

2010-2011 Year 1 1 October 2010 to 5 April 2011
2011-2012 Year 2 12 months to 30 September 2011
2012-2013 Year 3 12 months to 30 September 2012

 

The period from 1 October 2010 to 5 April 2011 (187 days) is an `overlap period’.

Example 2 – more than one overlap period

The business in Example 1 continues. In 2015-2016 the accounting date is changed from 30 September to 30 April. The accounts for the 12 months to 30 September 2014 show a profit of £75,000. The relevant conditions for a change of basis period are met (see BIM81045).

The basis periods are:

2014-2015 Year 5 12 months to 30 September 2014
2015-2016 Year 6 12 months to 30 April 2015
2016-2017 Year 7 12 months to 30 April 2016

 

The period from 1 May 2014 to 30 September 2014 (153 days) is an `overlap period’.

If the taxable profit for 2015-2016 is computed using days, it includes the profits for the `overlap period’ of 153 days (£75,000 x 153/365 = £31,438).

Adding together the overlap profits for the first overlap period of 187 days in Example 1 (£23,054) and the second overlap period of 153 days (£31,438), gives total overlap profits of £54,492 over 340 days.

Tax Cafe point out in their guide ‘Small Business Tax Saving Tactics

Why Hasn’t Everyone ‘Cashed In’ Their Overlap Relief Already?

There are two ways to gain access to your overlap relief: cease trading or change your accounting date.

Ceasing to trade is a drastic step: generally not something you are likely to do purely for tax planning purposes. However, it is worth noting that transferring your business to a company is also classed as ‘ceasing to trade’ for these purposes.

Changing your accounting date to access your overlap relief is less drastic, but the downside is that the relief only arises where you are being taxed on more than twelve months’ worth of profit. Despite this, however, there is still generally an overall saving to be made where current profits are at a lower level than the profits arising when the ‘overlap’ first arose. So, with the economy in the state it’s in, now could be a good time to ‘cash in’!

There is also some useful advice in Helpsheet HS222

steve@bicknells.net

Limited Liability Partnerships

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Limited Liability Partnerships came under closer scrutiny in the Budget 2013.  The aim is to target LLPs which use the structure to hide the employment relationship of the partners and those with Corporate partners who divert business profits to the corporate partners in order to avoid tax.

Although the following measures come in to play from 6th April this year, the anti-avoidance measures make it effective from 5th December 2013.  This is to prevent partnerships changing their arrangements in order to avoid the new rules.

The two main areas of focus are salaried or fixed profit share partners which is referred to as disguised employment, and profit and loss sharing arrangements within mixed partnerships.

LLP partners with fixed profit share

HMRC believe that many members of an LLP should be taxed as employees, because they don’t see them is true partners.

A new test has been brought in which has three conditions.  Where the member tested meets all three conditions then he or she must be treated as an employed salaried member and be brought within the PAYE system with tax and class I NIC applied to any earnings,  which had previously been Taxed as profit share.

This also means that if a vehicle is provided for the members use by the partnership this will be taxed as a benefit in kind.  As such the member will have to pay tax and NIC and the LLP will have to pay Class 1a NIC on the benefit.

HMRC does actually accept that employment tax rules are imposed on the individual but that in fact the individual has no employment rights. This is because he is not actually an employee for employment law purposes.

The test is as follows. The provision is triggered when all conditions A to C are met:

Condition A: The Member is performing services for the LLP in his capacity as a member of the partnership and it’s reasonable to expect as a result of these arrangements that any amounts paid to him in respect of his services will be wholly or substantially wholly a disguised salary. In other words if his reward package is comparable to that received by an employee, either a fixed salary or a variable bonus based on performance rather than profit share.

Condition B: The Member doesn’t have significant influence over the affairs of the partnership.

Condition C: The Member’s capital contribution to the LLP is less than 25% of the total amount of his disguised salary which would be expected to be paid in the relevant tax year by the LLP in respect of the members performance of services as a member. Normally the relevant time would be the beginning of the new tax year.

These tests must be reviewed each tax year.

Corporate LLP Members

This applies to partnerships who have members which are not subject to UK income tax for example this might be a limited company. The problem here is that HMRC believes these structures are used to avoid tax on a very large scale.   Where for example an individual member introduces his Ltd company as a corporate member, and which then receives a profit share that would otherwise have been paid to the individual member.   If the Member then has the power to enjoy the fund which had been paid to his company then:

  • The individual member will be treated as a salaried member.
  • The amount paid to the company will be treated as employment income paid to the individual member.

There are anti-avoidance rules are in place to catch anyone trying to put measures in place to counteract these new rules.

fiona@grant-jonesaccountancy.com

http://www.grant-jonesaccountancy.com

How does Overlap Relief work?

Overlap Relief applies to Sole Traders and Partnerships.

Where 5 April is used as the annual accounting date throughout the entire life of a business, there will be no overlaps between basis periods. In such cases the total profits assessed to income tax will automatically equal the total profits made during the life of the business.

In any other case there will be one or more years in which the basis periods for two successive tax years overlap. These overlaps may occur:

  • In years 2 or 3 during the period in which the basis periods and accounting periods are brought into alignment; or
  • During the period of realignment following a change of accounting date.

To ensure that the total profits assessed to income tax exactly equal the total profits made during the life of the business, “overlap relief” is given.

The amount available to be given as overlap relief is the amount of profits which arise in any overlap periods. An overlap period is a period which falls within two basis periods. Guidance on computing overlap relief is at BIM71080.

Overlap relief is given as a deduction in calculating the profits of the trade for the tax year:

  • in which the trade ceases (see BIM71095), and / or
  • an earlier tax year in which a change of accounting date occurs if the basis period for that tax year is longer than 12 months (see BIM71090).

Here is an example:

A business commences on 1 October 2010. The first accounts are made up for the 12 months to 30 September 2011 and show a profit of £45,000.

The basis periods for the first 3 tax years are:

 

2010-2011 Year 1 1 October 2010 to 5 April 2011
2011-2012 Year 2 12 months to 30 September 2011
2012-2013 Year 3 12 months to 30 September 2012

 

The period from 1 October 2010 to 5 April 2011 (187 days) is an “overlap period”.

steve@bicknells.net

 

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