Basis periods for sole traders starting a new business

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By Fiona Winter, Director of Development, CA Education

10 August 2017

For entrepreneurs starting their own business, it is possible to choose whatever accounting date suits the business – but tax is paid for the fiscal year, running from 6 April to 5 April. We go back to basics on the rules of the start of trade and what this means. 

By using “basis periods” our taxable profits for different accounting periods are allocated to the correct fiscal year. These rules are covered in TPS Tax Module 1 and within the ITP Taxation of Individuals notes.

For an established business the rules are relatively simple.  Once the accounting profits of the year have been adjusted to become taxable profits (a reminder in our back to basics article on adjusting profits) these will be taxed in whichever fiscal year the accounting period ends:  

  • A trader using a 28 February 2017 year end will have these profits taxed as profits of 2016/17
  • A trader with a 30 June 2017 year end will have these profits taxed as profits of 2017/18.

Start of trade

The rules are more complex for the start of trade, and will affect the fiscal year in which you start trading and the one following that. If a client was to start trading on 17 August 2017 (i.e. during 2017/18) this will mean they follow “commencement rules” for 2017/18 and 2018/19, moving on to the normal rules from 2019/20.  

In the fiscal year that trade is begun, tax will be applied to profits made during that fiscal year. This normally involves apportioning the profits of the first accounting period to determine the amount attributable up to and including 5 April only. This is done on a pure time-apportionment basis, not by considering individual transactions.

The second fiscal year will be taxed on one of three bases, depending on the accounting dates of the business. Using the business start date of 17 August 2017 per above we determined that the second fiscal year would be 2018/19. To work out what to tax in 2018/19 the following approach can be used: 

  1. Is there a set of accounts that ends during 2018/19? If yes, move to Q2. If no, tax the actual profits of 2018/19 (i.e. 6 April to 5 April) using time apportionment.
  2. Is the set of accounts that ends in 2018/19 at least 12 months long? If yes, tax the 12 months of profits to that accounting date. If no, tax the profits of the first 12 months of the trade.  

Basis period for second fiscal year: Flowchart

Basis period for second fiscal year: Flowchart

When we reach the third fiscal year (2019/2020 in this example) we will use the normal approach.

Topics

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