September 2020
Neil Da Costa explains a subject that causes many students problems in the exam hall.
I n this article I am going to show you how to ‘keep it simple’. Having been an Advanced
Tax lecturer for more than 20 years I am fully aware of which areas strike terror into tax students’ hearts. These areas feature regularly in the tax exams and by ensuring you understand them, you can be confident of earning these marks in the question. Here, I will be explaining the current year basis opening year rules using simple examples.
The bedrock for taxing self-employed individuals is the current year basis or CYB. Under CYB, the profits taxed are those of the 12-month accounting period ending in the current tax year.
Alina has been trading for many years and prepares accounts to 31 December. For the year end 31 December 2022, she has taxable profits of £50,000. In which tax year will these profits be taxed?
31 December 2022 falls into the tax year 22/23 and the accounting period is 12 months in length so Alina will be taxed on £50,000 profits in 22/23. These profits are subject to income tax and national insurance.
When a sole trader starts trading, the assessment for the first tax year is always based on the actual profits from the date of commencement to the 5 April of the first tax year.
The second tax year is more technical, and this is where the confusion sets in. The rules for the second tax year are based on the length of the accounting period ending in the second tax year. If the accounting period is 12 months in length, the assessment is based on current year basis. The third tax year is almost always based on the current year basis.
Amobi starts trading on 1.1.2022 and prepared accounts 31 December.
His first two periods are as follows:
1.1.2022 – 31.12.2022 £24,000 profits
1.1.2023 – 31.12.2023 £36,000 profits
The first tax year is 21/22
Tax actual profits from 1.1.2022 – 5.4.2022 24,000 x3/12 = £6,000
The second tax year is 22/23
The accounting period ending in the second tax year is 31.12.22 which is 12 months in length so tax under CYB
Tax 1.1.2022 – 31.12.2022 £24,000
The third tax year is 23/24
The accounting period ending in the third tax year is 31.12.23 which is 12 months in length so tax under CYB
Tax 1.1.2023 – 31.12.2023 £36,000
Amobi’s profits for the first three months of £6,000 have been taxed twice. These are called overlap profits and are deducted from the final year’s assessment.
CYB can only be used for the second tax year if the accounting period is 12 months in length. If the accounting period is not 12 months in length, then special rules apply in order to tax 12 months in the second tax year. If the accounting period is less than 12 months, tax the first 12 months of trading. If the accounting period is more than 12 months, tax the last 12 months of trading. If there is no accounting period ending in the second tax year, tax the profits from 6 April to 5 April in the second tax year.
Rajiv starts trading on 1.1.2022 and prepared accounts 30 June.
His first two periods are as follows:
1.1.2022 – 30.6.2022 £24,000 profits
1.7.2022 – 30.6.2023 £36,000 profits
The first tax year is 21/22
Tax actual profits from 1.1.2022 – 5.4.2022 24,000 x3/6 = £12,000
The second tax year is 22/23
The accounting period ending in the second tax year is 30.6.22 which is just 6 months in in length so tax the first 12 months of trading
Tax 1.1.2022 – 31.12.2022 £24,000 + 6/12 x £36,000 = £42,000
The third tax year is 23/24
The accounting period ending in the third tax year is 31.12.23 which is 12 months in length so tax under CYB
Tax 1.1.2023 – 31.12.2023 £36,000
Rajiv has overlap profits of £12,000 + 6/12 x £36,000 = £30,000 which are deducted from the final year’s assessment.
Emma starts trading on 1.1.2022 and prepared accounts for the 18 months to 30 June 2023.
Her first period was as follows
1.1.2022 – 30.6.2023 £72,000 profits
The first tax year is 21/22
Tax actual profits from 1.1.2022 – 5.4.2022 £72,000 x3/18 = £12,000
The second tax year is 22/23
There is no accounting period ending in the second tax year so tax the actual profits of the second tax year
Tax 6.4.2022 – 5.4.2023 £72,000 x12/18 = £48,000
The third tax year is 23/24
The accounting period ending in the third tax year is 30.6.2023 which is 18 months in length, so it is not possible to tax under CYB
As the accounting period is more than 12 months, tax the last 12 months of trading
1.7.2022 – 30.6.2023 £72,000 x12/18 = £48,000
Emma’s overlap profits are 1.7.2022 – 5.4.2023 which are 9/12 x £72,000 = £36,000.
An easy method of computing overlap profits is as a balancing figure.
Profits taxed are £12,000 + £48,000 + £48,000 = £108,000
The actual profits are £72,000
Overlap profits are £108,000 – £72,000 = £36,000
Both methods for computing overlap profits are acceptable in the exam.
You have now mastered the basics of CYB opening year rules and will be able to approach exam questions without trepidation.
• Neil Da Costa is a senior tax lecturer with Kaplan.
