Taxation of the unincorporated business (for P6 (UK))

The new business (for P6 (UK))
Part 3 of 4

This is the Finance Act 2016 version of this article. It is relevant for candidates sitting the P6 (UK) exam in the period 1 April 2017 to 31 March 2018. Candidates sitting P6 (UK) after 31 March 2018 should refer to the Finance Act 2017 version of this article (to be published on the ACCA website in 2018).

So far in this article we have compared trading as an unincorporated trader with trading through a company by reference to the various relevant taxes. We are now going to look at the choice of year end for an unincorporated trader.

CHOICE OF YEAR END

The choice of year end affects when the profits of the business will be subject to income tax. For example, where a 31 March year end is chosen, the profits earned in a tax year are taxed in that same tax year (the profits earned in the year ended 31 March 2016 are taxed in the tax year 2015/16). Alternatively, where a 30 April year end is chosen, the majority of the profits earned in a tax year are not subject to income tax until the following tax year (the profits earned in the year ended 30 April 2016 are taxed in the tax year 2016/17).

When a new business begins to trade, the profits assessed to tax in the first two tax years will vary, perhaps considerably, depending on the choice of year end.

Illustration 1
Mizuki began trading on 1 January 2017. Her tax adjusted profits per month are set out below.

£
January to March 2017
(three months)
3,000
April to September 2017
(six months)
4,000
October to December 2017
(three months)
8,000
January 2018 onwards12,000

If Mizuki adopts a 31 March year end, her taxable trading income for the first three tax years of trading would be calculated as follows:

1. Profit for each trading period

£
Three months ending 31 March 2017 (£3,000 x 3)9,000
Year ending 31 March 2018
((£4,000 x 6) + (£8,000 x 3) + (£12,000 x 3))
84,000
Year ending 31 March 2019 (£12,000 x 12)144,000

2. Taxable profit for each tax year

£
2016/17
(1 January 2017
to 5 April 2017)
9,000
2017/18
(Year ending 31 March 2018)
84,000
2018/19
(Year ending 31 March 2019)
144,000
Total taxable profits for the first three tax years237,000

If Mizuki adopts a 30 April year end, her taxable trading income for the first three tax years of trading would be calculated as follows:

1. Profit for each trading period

£
Four months ending 30 April 2017 ((£3,000 x 3) + £4,000)13,000
Year ending 30 April 2018
(£4,000 x 5) + (£8,000 x 3) + (£12,000 x 4)
92,000
Year ending 30 April 2019
(£12,000 x 12)
144,000

2. Taxable profit for each tax year

£
2016/17
(1 January 2017
to 5 April 2017)
3/4 x £13,000
9,750
2017/18 (1 January 2017
to 31 December 2017)
£13,000 + (8/12 x £92,000)
74,333
2018/19
(Year ending 30 April 2018)
92,000
Total taxable profits for the first three tax years176,083

With a 30 April year end the taxable profits in the first three tax years are £60,917 (£237,000 – £176,083) less. This is because the profits are increasing and early profits are being taxed twice (giving rise to overlap profits) in place of later, higher profits.

This is a timing difference as opposed to an absolute saving. The profits earned in the period 1 May 2018 to 31 March 2019 of £132,000 (£12,000 x 11) are not taxed in the first three tax years if a 30 April year end is chosen. These profits, as reduced by the overlap profits of £71,083 (£9,750 + £61,333 (8/12 x £92,000)), represent the difference between the total profits taxed.

Conclusion

When considering the choice of year end, it may be necessary to work with monthly profit figures. In these circumstances you must first calculate the profits for the trading periods by reference to the monthly profits and then apply the basis of assessment rules in order to determine the taxable profits for the tax years.

Note: The unincorporated trader is considered further in:

• Taxation of the unincorporated business – the existing business (for P6 (UK))

Written by a member of the P6 (UK) examining team

The comments in this article do not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content of this article as the basis of any decision. The authors and ACCA expressly disclaim all liability to any person in respect of any indirect, incidental, consequential or other damages relating to the use of this article.