ACCA F6 FA09 Study Text 2010
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Chapter 8: The basis of assessment rules for unincorporated businesses
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The opening year rules
The need for special opening year rules
Calculating the opening year assessments
2 The opening year rules
2.1 The need for special opening year rules
When an individual starts to trade, he must choose a convenient ending date for the
accounting period. Having chosen his accounting period closing date, his first set of
accounts may be of any length:
more than 12 months,
less than 12 months, or
exactly equal to 12 months.
As a result, if the CYB rule explained above is applied, it would be possible for a
trader to avoid paying tax in the first tax year of trading. For example, if a trader
commences trade on 1 January 2010 and prepares the first set of accounts to 31
December 2010, he was trading in the tax year 2009/10. However, as there are no
accounts which end in that tax year, application of the CYB rule would mean there
is no assessment to tax for 2009/10.
To ensure that some profits of the business are taxed in every tax year in which the
individual is in business, the CYB rule is not used:
in the opening year itself, and
usually the next few years as well.
Instead, special opening year rules are applied.
2.2 Calculating the opening year assessments
The opening year assessment rules are summarised below.
Tax year Basis period
First tax year
Assess on an actual tax year basis
(i.e. from the date the trade started to the following
5 April)
Second tax year
See the decision table below
Third tax year
Assess the 12 months to the accounting date
ending in the third tax year
Fourth tax year onwards
Assess using CYB rules as described above
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The rules for the second tax year are set out in the following decision table. The
approach is based on the answers to two questions
Question 1:
Are there accounts
which end in the
tax year?
Decision:
Assess on an actual
tax year basis
(i.e. 6 April to 5 April)
Decision:
Assess the
12 months to the
accounting date
ending in the
second tax year
In applying these assessment rules it is assumed that profits accrue evenly over
time. Therefore, where calculations to obtain an assessment require profits to be
taken from more than one set of accounts, the profits must be time-apportioned.
The tax legislation requires apportionment in days, but in the examination
calculations should be made to the nearest month.
A consequence of applying the opening year rules is that some profits will be
assessed to tax more than once. These profits are known as overlap profits.
Relief is given for overlap profits in the final tax year on the cessation of trade, or
possibly earlier if the business changes its accounting date.
Second tax year
From the decision table above, it can be seen that there are four possible decisions
for the second tax year.
Each of the four possible scenarios is illustrated on the following examples.
Chapter 8: The basis of assessment rules for unincorporated businesses
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Example 1
Katie started to trade on 1 October 2008 and decided to prepare her accounts to 30
September each year. Her results for the first two years are as follows:
Yearended Adjustedprofitbefore
capitalallowances
Capitalallowances
£ £
30September2009 21,600 5,600
30September2010 64,800 6,500
Required
Calculate Katie’s trading income assessments for the first three tax years, and the
overlap profits arising from the application of the opening year rules.
Answer
Step 1. Calculate the adjusted profit after capital allowances for each accounting
period
Yearended Adjustedprofitaftercapital
allowances
£
30Sept2009 (£21,600‐£5,600) 16,000
30Sept2010 (£64,800‐£6,500) 58,300
Step 2. Work out the basis period for the first tax year of trading
Trading starts on 1 October 2008 = In tax year 2008/09 = First tax year.
Tax year 1: Tax the profits from 1 October 2008 to 5 April 2009.
Step 3. Work out the basis period for the second tax year
Second tax year = 2009/10. Ask two questions:
Are there accounts which end in the tax year? Yes = Year ended 30 September 2009
Are these accounts 12 months in length? Yes
Decision Assess the profits of those 12 months
Step 4. Summarise and calculate the trading income assessments
Tax
year
Basisof
assessment
Basisperiod
Workings
Trading
income
assessment
£
2008/09 Actual 1.10.2008–5.4.2009 6/12×£16,0008,000
2009/10 12monthsending
insecondyear
Yearended30.9.2009
16,000
2010/11 12monthsending
inthirdyear
Yearended30.9.2010 58,300
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Step 5. If required, calculate the overlap profits
Profits are assessed more than once for the period 1.10.2008 – 5.4.2009.
Overlap profits = 6/12 × £16,000 = £8,000.
Example 2
Len started to trade on 1 November 2007 and decided to prepare his accounts to 31
May each year. His results for the first two accounting periods are as follows:
Periodended
Adjustedprofitaftercapitalallowances
£
31May2008 13,400
31May2009 51,470
Required
Calculate the trading income assessments for Len for the first three tax years and
calculate the overlap profits.
Answer
Trading starts on 1 November 2007 = In tax year 2007/08 = First tax year.
First tax year: Assess profits from 1 November 2007 to 5 April 2008.
Second tax year = 2008/09. Ask two questions:
Are there accounts which end in the tax year? Yes = 7 months ended 31 May 2008
Are these accounts 12 months in length? No: less than 12 months
Decision Assess the profits of the first 12 months
Tax
year
Basisof
assessment
Basisperiod
Workings
(nearest
month)
Trading
income
assessment
£
2007/08 Actual 1.11.2007–5.4.2008 5/7×£13,400 9,571
2008/09 First12months 1.11.2007–31.10.2008 £13,400+
(5/12×£51,470)
34,846
2009/10 12monthsending
inthirdyear
Yearended31.5.2009
51,470
Overlap profits
£
1.11.2007–5.4.2008
5/7×£13,400 9,571
1.6.2008–31.10.2008 5/12×£51,470 21,446
31,017
Chapter 8: The basis of assessment rules for unincorporated businesses
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Example 3
Mary started to trade on 1 June 2007 and decided to prepare her first accounts to 31
August 2008 and then to 31 August each year. Her results for the first two
accounting periods are as follows:
Periodended
Adjustedprofitaftercapitalallowances
£
31August2008 20,110
31August2009
77,200
Required
Calculate Mary’s first three years’ trading income assessments and the overlap
profits.
Answer
Trading starts on 1 June 2007 = In tax year 2007/08 = First tax year.
First tax year: Assess the profits from 1 June 2007 to 5 April 2008.
Second tax year = 2008/09. Ask two questions:
Are there accounts which end in the tax
year?
Yes = 15 months ended 31 August 2008
Are these accounts 12 months in length? No: More than 12 months
Decision Assess profits for the 12 months ending
on 31 August 2008
Tax
year
Basisof
assessment
Basisperiod
Workings(to
nearestmonth)
Trading
income
assessment
£
2007/08 Actual 1.6.2007–5.4.2008 10/15×£20,110 13,407
2008/09 12monthsending
insecondyear
1.9.2007–31.8.2008
12/15×£20,110
16,088
2009/10 12monthsending
inthirdyear
Yearended
31.8.2009
77,200
Overlap profits
1.9.2007 – 5.4.2008: 7/15 × £20,110 = £9,385.
Example 4
Nicholas started to trade on 1 January 2007 and decided to prepare his first accounts
to 30 April 2008 and thereafter to 30 April each year. His results for the first two
accounting periods are as follows:
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Periodended Adjustedprofitaftercapitalallowances
£
30April2008 34,140
30April2009
51,250
Required
Calculate Nicholas’ first four years’ trading income assessments and the overlap
profits.
Answer
Trading starts on 1 January 2007 = In tax year 2006/07 = First tax year.
First tax year: Assess the profits from 1 January 2007 to 5 April 2007.
Second tax year = 2007/08. Ask two questions:
Are there accounts which end in the tax year? No
Decision Assess the actual profits of the tax
year: from 6 April 2007 to 5 April
2008
Third tax year = 2008/09. The 16-month accounts to 30 April 2008 end in the third
tax year.
Decision = Assess the 12 months running up to the accounting end date that ends in
the third tax year (i.e. the 12 months to 30 April 2008).
Tax
year
Basisof
assessment
Basisperiod
Workings
(tonearest
month)
Trading
income
assessment
£
2006/07 Actual 1.1.2007–5.4.2007 3/16×£34,140 6,401
2007/08 Actual 6.4.2007–5.4.2008 12/16×£34,140 25,605
2008/09 12monthsending
inthirdyear
1.5.2007–30.4.2008 12/16×£34,140 25,605
2009/10 CYB Yearended30.4.2009 51,250
Overlap profits
1.5.2007 – 5.4.2008: 11/16 × £34,140 = £23,471.
Chapter 8: The basis of assessment rules for unincorporated businesses
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The closing year rules
The need for special closing year rules
Calculating the closing year assessments
3 The closing year rules
3.1 The need for special closing year rules
The primary aim of the basis of assessment rules is that the business should be taxed
on the exact amount of adjusted profits after capital allowances earned over the
entire life of the business.
In the opening years, overlap profits are assessed to tax more than once. To ensure
that no more than the exact amount of adjusted profits is assessed to tax, relief is
given for the overlap profits in the final tax year.
3.2 Calculating the closing year assessments
The closing year rules and approach are summarised as follows:
Step 1. Work out which tax year is the final tax year.
Step 2. Work out the trading income assessment of the penultimate year using
the normal CYB rules.
Step 3. Work out the final trading income assessment as follows:
£
All profits not yet assessed (i.e. profits from the end of the accounting
period ending in the penultimate year to the date of cessation)
X
Minus: Overlap relief (X)
Closing year trading income assessment X
Example
Owen has been trading for many years preparing accounts to 31 May each year. His
overlap profits are £3,650. Owen ceased to trade on 30 September 2009 and has
provided the following results for the last three accounting periods:
Periodended
Adjustedprofit
beforecapital
allowances
Capital
allowances
£ £
31May2008 38,610 13,160
31May2009
23,200 10,000
30September2009
15,300 12,350
Required
Calculate Owen’s last two trading income assessments.
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Answer
The adjusted profit after capital allowances for each accounting period
Yearended
Adjustedprofitaftercapital
allowances
£
31May2008 (£38,610‐£13,160) 25,450
31May2009 (£23,200‐£10,000) 13,200
30Sept2009 (£15,300‐£12,350) 2,950
Step 1: Work out the final tax year
Cessation of trade: 30 September 2009 = In tax year 2009/10 = Last tax year.
Step 2: Work out the trading income assessment of the penultimate year
2008/09 CYB Yearended31.5.2008 £25,450
Step 3: Work out the final trading income assessment
£
Profitsnotyetassessed(1.6.2008–30.9.2009)
Yearended31May2009 13,200
Periodended30September2009 2,950
Minusoverlaprelief
(3,650)
Closingyeartradingincomeassessment
12,500
Chapter 8: The basis of assessment rules for unincorporated businesses
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Choice of accounting date
A date early in the tax year
A date late in the tax year
4 Choice of accounting date
4.1 A date early in the tax year
A trader has a choice of accounting date. If he picks a date early in the tax year, for
example 30 April, this will have the advantage of maximising the gap between
earning profits and paying the tax on them. In 2009/10, for example, the assessment
will be based on the profits of the year ended 30 April 2009. If profits are rising, this
will produce a lower assessment than an accounting date of 31 March 2010.
However, a date early in the tax year may result in the assessment of more than 12
months’ profits in the final year. See the previous example in which Owen was
assessed on the profits of both the year ended 31 May 2009 and the period ended 30
September 2009 in 2009/10.
4.2 A date late in the tax year
A date late in the tax year, for example 31 March, will avoid the bunching of profits
in the final tax year. So, in the previous example, if Owen had had an accounting
date of 31 March instead of 31 May, his final tax year would have been based only
on the profits of the period ended 30 September 2009 as the profits for the year
ended 31 March 2009 would have been assessed in the penultimate year.
Choosing 31 March as the accounting date would also avoid overlap profits under
the commencement rules. In addition, it has the advantage of being easy for the
taxpayer to understand. However, its drawback is that it minimises the gap between
earning profits and paying tax on them.
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The rules on a change of accounting date
The need for special change of accounting date rules
The conditions for a valid change of accounting date
Calculating the change of accounting date assessments
5 The rules on a change of accounting date
5.1 The need for special change of accounting date rules
Apart from in the first and last tax years, the basis of assessment rules seek to assess
12 months’ worth of profits every tax year.
However, when an unincorporated business decides to change its accounting date,
it will need to produce a set of accounts that is either more than or less than 12
months in length.
The normal current year basis of assessment cannot be used, as the accounts ending
in the tax year will not be exactly 12 months. Therefore special rules are required to
deal with a change in accounting date.
Certain conditions must be satisfied for a business to be allowed to treat a change of
accounting date as valid for tax purposes. These conditions exist primarily to
prevent businesses changing their accounting date frequently in an attempt to gain
a tax advantage.
5.2 The conditions for a valid change of accounting date
For a change of accounting date to be valid for tax purposes, the following
conditions must be satisfied:
The first accounting period to the new accounting end date must not exceed 18
months in length.
The business must not have changed its accounting date in the previous five
years or, if it has, it must have justifiable commercial reasons for making a
further change in the five year period.
HMRC must be notified of the change by 31 January following the tax year in
which the first accounting period to the new date ends.
If the conditions are not satisfied, HMRC will ignore the new accounting date for
taxation purposes and continue to assess profits based on the old date. If necessary,
profit figures will be apportioned accordingly.
5.3 Calculating the change of accounting date assessments
The change of accounting date rules and approach are summarised below.