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Doubletrouble

Income tax basis periods continue to cause students problems in the exam hall. Lynne Wiseman offers some pointers on the best way to showcase your talents

Many students at F6 (even P6!) struggle with opening year rules. The problem is that students try to apply logic to the accounting periods to avoid taxing the same profits twice. Remember, HMRC don’t mind taxing you more than once on the same profits!
THE RULES
• Year one: tax profits from the first day of trade to the first 5 April and identify which tax year this falls in.
If you start to trade on 1.1.08 and make accounts up to 31.8.08 then you will tax 1.1.08 to 5.4.08, which is tax year 07/08.
If eight months profits are £8,000 then you will be taxed on 3/8ths x £8,000.
So, in 07/08 £3,000 will be taxable.
• Year two: write down the tax year
(eg 08/09) and ask yourself: “Is there a set of accounts that ends in this tax year?”
1. If NO then tax the profit that arises in the tax year 6/4 to 5/4. For example, if you started to trade on 1.1.08 and produced a long set of accounts ending on 31.5.09, then you would not have an accounts year ending in 08/09. In this case you would need to tax 12/17ths of the profits from those accounts.
2. if YES then the accounting period will be either:
a. Longer than 12 months – tax the last 12 months of the long period.
For example, if you started to trade on 1.1.08 and made your first set of accounts up to 31.3.09, then you would tax 1.4.08 to 31.3.09 ie 12/15ths of the long period.
b. Or, Shorter than 12 months – tax the first 12 months of trade.
For example, if you started to trade on 1.1.08 and made your first set of accounts up to 30.9.08, then you would need to tax 1.1.08 to 31.12.08. In this case you would need the nine months profits to 30.9.08 and 3/12ths of the profits of the next accounting period.
c. Or, 12 months exactly – tax those 12 months.
For example, if you started to trade on 1.1.08 and your year end was 31.12.08 then you would tax those profits in full. This is called Current Year Basis and this is how you would tax the future years.
• Year three onwards: write down the tax year, ask yourself the same question as in year two and repeat the process until you get to current year basis. Eventually, every year will be current year basis and you will be taxing 12 months’ profit in each tax year.
Problem: if you start to trade on 1.1.08 and make your accounts up to 31.12.08, then in year one you will tax 3/12ths of the profits to 5 April and then in year two you will tax the full 12 months of the same profits! The three months are referred to as overlap profits and a trader can only get relief for the double tax when he changes his accounting date or ceases to trade.
Remember: if you follow the rules and ignore the nagging logic that’s telling you ‘you’ve already taxed those profits’ you’ll be fine!
• Lynne Wiseman lectures at Reed Business School

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