Overlap Relief and Basis Period Reform

What is Overlap Relief?

Overlap relief is a tax adjustment that compensates self-employed individuals and partners for profits that were taxed twice under the old basis period rules. When a business started trading, its first profits were often assessed in more than one tax year, creating overlap profits. The overlap relief deduction was available when the business changed its accounting date or ceased trading.

From the 2024/25 tax year, the old basis period system has been replaced by the tax year basis, making overlap relief relevant primarily during the transition.

The Old Basis Period Rules

Under the previous system, self-assessment for sole traders and partnerships worked as follows:

• A business was taxed on profits from its accounting period ending in the tax year
• If a business had a 31 December year-end, profits for the year ending 31 December 2022 were taxed in the 2022/23 tax year (which ran 6 April 2022 to 5 April 2023)
• In the opening years of a new business, special rules could result in the same profits being taxed in two consecutive tax years

How Overlap Arose

A business starting on 1 July 2018 with a 30 June year-end would have the following basis periods:

The profits from 1 July 2018 to 5 April 2019 (9 months) were taxed in both 2018/19 and as part of the 12-month period in 2019/20. These 9 months of double-taxed profits became the overlap profit, and the relief was stored until the business changed its year-end or ceased.

The Basis Period Reform

The Finance Act 2022 introduced the basis period reform, which transitions all unincorporated businesses to a tax year basis from 2024/25 onwards:

From 2024/25, all sole traders and partners are taxed on profits arising in the tax year (6 April to 5 April), regardless of their accounting date.

The Transition Year (2023/24)

The 2023/24 tax year is the transition year, during which businesses move from the old system to the new. In this year:

1. The business is taxed on profits from the end of the basis period for 2022/23 up to 5 April 2024
2. This may cover more than 12 months of profits
3. Overlap relief is deducted from the transition profit
4. The remaining excess profit can be spread over five tax years (2023/24 to 2027/28)

Transition Calculation

For a business with a 31 December year-end:

From this total, the business deducts its overlap profit (stored from the opening years). The remaining transition profit can be spread equally over five years.

Spreading the Transition Profit

A business can elect to be taxed on more than one-fifth in any year, which might be beneficial if the business has losses or lower income tax liability in that year.

Finding Your Overlap Profit

Many businesses that have been trading for years may not know their overlap profit figure. Sources include:

• The tax return for the year the business started (or the second year of trading)
• HMRC records — you can write to HMRC to request your overlap profit figure
• Your accountant’s working papers from the opening years
• The partnership statement (for partners in a partnership)

If no record can be found, HMRC may accept a reasonable estimate, but this can be difficult to agree.

Businesses with a 31 March or 5 April Year-End

Businesses that already used a 31 March or 5 April year-end were effectively already on the tax year basis. For these businesses:

• There is no transition adjustment needed
• Overlap profits (if any) are typically nil or very small
• The move to the tax year basis has minimal practical impact

HMRC treats a year-end between 31 March and 4 April as equivalent to 5 April for these purposes.

Impact on Accounting Dates

Under the new rules, the accounting date becomes less significant for tax purposes because profits are always allocated to the tax year in which they arise. However, businesses may still choose to:

• Change their year-end to 31 March or 5 April to simplify calculations and avoid apportioning profits across tax years
• Keep a different year-end for commercial reasons, accepting that some apportionment will be needed each year

If the accounting date does not align with the tax year, profits are apportioned on a time basis (or a more appropriate basis if justified) to fit the 6 April to 5 April period.

Reporting on the Tax Return

For the 2023/24 transition year and subsequent years under the tax year basis:

• Transition profits are reported on the self-employment or partnership pages of the self-assessment return
• The amount of overlap relief claimed is shown separately
• The spreading election (if applicable) is made on the return
• From 2024/25, profits are reported on the tax year basis with any apportionment shown in the computation

Practical Implications

For Sole Traders

• Review your overlap profit figure now if you have not already
• Consider whether changing your accounting date to 31 March or 5 April simplifies ongoing compliance
• If the transition year produces a large tax bill, ensure you have cash available or use the spreading option

For Partnerships

• Each partner’s share of the transition profit may differ depending on when they joined the partnership
• Partners who joined in recent years may have little or no overlap relief available
• The partnership must provide each partner with their share of the transition figures

For Accountants and Advisers

• Check that overlap relief figures are accurately recorded in your client files
• Advise on the optimal spreading strategy based on the client’s projected income
• Consider the interaction with other reliefs, such as pension contributions and trading loss claims