What are overlap profits?.

Anyone who has been self-employed (including being a partner or member in a partnership or LLP) is likely to have heard of overlap profits, but to many they remain a mystery. What are they, how are they calculated, and what effect do they have on your tax position? For the purpose of this article we will assume that you are a partner in a partnership.

Overlap profits will arise for any partner in a partnership who does not have an accounting year-end of 31st March, because there is a mismatch between the accounting year-end and the end of the UK tax year (5th April; HMRC treat 31st March and 5th April as being coterminous for this purpose).

You will generally pay income tax (and National Insurance) on your share of the profits for the accounting year which ends in the tax year in question. For example, if the partnership has an accounting year-end of 30th April, in 2018/19 (6 April 2018 to 5 April 2019) you would be taxed on your share of the profits for the accounting year ended 30 April 2018.

However, there are special rules which apply in the first 1 to 3 years when someone becomes a partner to ensure that they start paying tax on their share of the profits as soon as possible. Unfortunately this will result in some profits being taxed more than once in those first 1 to 3 years (the number of years which are affected depends on the date on which you become a partner and also the partnership’s accounting year-end).

Those profits that are taxed twice in the early years of being a partner are then relieved when you cease to be a partner, whether that be via retirement or by leaving the partnership, or the partnership changes its accounting year-end date, so that over the period that you are a partner you will only pay tax on your total profits once.

Example

You became a partner on 1^st October 2015, with a profit share of £100,000 and the partnership’s accounting year-end is 30^th April.

• In the tax year 2015/16 you will be taxed on your share of the profit 1^st October 2015 to 5^th April 2016. This will amount to £50,000 (£100,000 x 6 months).  The tax on these profits is payable on 31^st January 2017.
• In the tax year 2016/17, although the accounting year ended 30^th April 2016 ends in that tax year, you have not been a partner for 12 months by 30^th April 2016, and so you are taxed on the profits for the first 12 months of being a partner, so 1^st October 2015 to 30^th September 2016. This will amount to £100,000. Payments on account of the tax on these profits are payable on 31^st January 2017 and 31^st July 2017, with any balancing payment being payable on 31^st January 2018.

Clearly the profits for the period 1^st October 2015 to 5^th April 2016 have been taxed both in 2015/16 and in 2016/17 and so overlap profits of £50,000 have arisen.  These overlap profits will be relieved when you cease to be a partner or if the partnership changes its accounting year-end date.

• In the tax year 2017/18 the accounting year ended 30^th April 2017 falls into this tax year, and you have been a partner for 12 months during that accounting year. You are taxed on the profits for the year ended 30^th April 2017.  This will amount to £100,000.  Payments on account of the tax on these profits are payable on 31^st January 2018 and 31^st July 2018, with any balancing payment being payable on 31^st January 2019.

Clearly the profits for the period 1^st May 2016 to 30^th September 2016 have been taxed both in 2016/17 and in 2017/18 and so overlap profits of £41,667 have arisen.  Your total overlap profits now total £91,667.

• In the tax year 2018/19 you are taxable on your share of the profits for the year ended 30^th April 2018, which is £100,000. This will amount to £100,000.  Payments on account of the tax on these profits are payable on 31^st January 2019 and 31^st July 2019, with any balancing payment being payable on 31^st January 2020.

You decide to leave the partnership/retire on 30th December 2019.

• In 2019/20 you will be taxable on your share of the profits for the year ended 30^th April 2019 PLUS the profits for the period 1^st May 2019 to 30th September 2019, which will total £141,667 (£100,000 plus £41,667), less the overlap profits generated in 2016/17 and 2017/18 totalling £91,667.  You are taxable on a total of £50,000.
• Payments on account of the tax on these profits are payable on 31^st January 2020 and 31^st July 2020, with any balancing payment being payable on 31^st January 2021 (so 16 months after you left the partnership).

Over the period when you are a partner you have earned profits of £400,000 and also paid tax on profits totalling £400,000.

For more information or to speak to one of our advisers please contact us here.

About the author

Heidi Reed

Heidi is responsible for overseeing the compliance process for many of our large professional service partnerships Share this content with your network: