## So what are the rules?

**Rule 1.**

In the first year, profits from the commencement of trade until the following 5^{th} of April are taxed. So for example, Tony Adams prepared his first year’s accounts up to the year ended 31^{st} December 2016. He made a profit of £120,000. As this is a 12 month period, he must have commenced trade on 1^{st} January 2016.

In the first tax year, we tax from the commencement of trade to the following 5^{th} of April. Which will be 5^{th} April 2016. We will therefore tax 3 months (we ignore the 5 days in April) of the 12 months accounting period. Resulting in the amount of profits which will be taxable being 3/12 x £120,000 = £30,000.

**Rule 2. **

In year two, the rule is we tax 12 months of profits, no matter what. So do we have a twelve month period ending in the second tax year? Which is 6^{th} April to the following 5^{th} April? In Tony’s case, the second tax year is 6^{th} April 2016 until 5^{th} April 2017, and his 12 month period ended 31^{st} December 2016 does fall into this period. Therefore, in the second year, the profits which will be taxed will be the full £120,000.

Note that Tony has made profits of £120,000 but has paid tax on profits of £150,000. The £30,000 of profits which have been taxed twice are known as “overlap profits”. These will be deducted from his profits when he ceases trading. At the end of his working life, his profits will have only been taxed once, but this might not be for a number of years. This highlights the fact that a bit of planning always helps when choosing your year-end.

However, we will not always have a 12 month period ending in the second year; but we do have to tax a 12 month period in the second year. So what do we do?

**Well we make one!**

If we have a 6 month period ending 30^{th} June 2016 where the profits were £60,000, we need to “borrow” 6 months of profit from the following period.

For example, if the following period was the year ended 30th June 2017, and taxable profits were £180,000, we would take 6/12^{th} of the profit of £180,000 and add this to the £60,000. This equates to taxable profits for the tax year of 16/17 of £150,000. This consists of £60,000 from the period ended 30^{th} June 16, and £90,000 from 6 months which we have borrowed from the year ended June 2017.

**Long accounting periods **

We may be faced with a long accounting period in the second year. We still need to tax a 12 month period in the second year, so we just take the last 12 months of the long accounting period. For example, Steve Bould had a 15^{th} month accounting period ending 31^{st} December 2016 where his taxable profits were £300,000. He would only be taxed on the last 12 months, so his taxable profits would be 12/15 x £300,000 = £240,000.

If the examiner is feeling really nasty, they might not give you an accounting period which ends in the second tax year. You may have an accounting period which spans the entire tax year. Either way, we will make a 12 month period as we tax from 6^{th} April at the beginning of the tax year, to the following 5^{th} April.

For example, John Jensen has an 18 month accounting period which ends 30^{th} June 2017. His taxable profits are £90,000. For the year 16/17, we do not have an accounting period which ends in the tax year, so we will just take 12 months of profit, from 6^{th} April 2016 to 5^{th} April 2017. This will be 12/18 x £90,000 =£60,000.

**So that is the second year, what happens in the third year?**

Well, in the third tax year, the odds are that you will have a 12 month period which ends in the third tax year, so you will just tax that. However, if you do not, you just follow the rules from year two.

**So that’s it, learn the rules and you cannot go wrong!**

## Your turn

Why don’t you have a go at the following scenario, and then watch me calculate the answers below.

Ray Parlour has the following accounting periods and profits:

6 month period ended 30^{th} June 2016 with profits of £30,000

12 month period ended 30^{th} June 2017 with profits of £120,000

What are the taxable profits in the following tax years?

2015/16

2016/17

2017/18

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