Overlap Profits and Overlap Relief Explained

Hello, I’m Sara, a Chartered Accountant who transitioned into running an online business. I understand just how daunting and confusing it can be to take the leap into self-employment. The questions, the uncertainties, and the steep learning curve are all challenges I’ve faced myself. Whether you’re in the early stages of planning to go self-employed, just dipping your toes into making money on your own terms, or already fully committed, this blog is dedicated to helping you every step of the way. Through detailed guides, expert tips, and practical advice, I aim to be your go-to resource. From mastering financial management and navigating tax obligations to setting up the foundations of your business, I’m here to provide you with the clarity and confidence you need to thrive in your self-employment journey.

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Curious about the impact of overlap profits and how overpaid tax can be reclaimed on cessation? You’ve come to the right place! This guide will explain what overlap profits are, how overlap relief works upon cessation, and provide examples to help clarify these concepts. If this applies to you, keep reading for all the details.

Table of Contents

Overlap Profits Explained
- 1.1 How Overlap Profits Arise
- 1.2 Overlap Profits from Changing Accounting Periods
- 1.3 Overlap Profits from Shortening Accounting Periods
How to Avoid Overlap Profit
What is Overlap Relief?
HMRC Overlap Relief for Changing Accounting Periods
How to Claim Overlap Relief
- 5.1 How to Claim Overlap Relief on Cessation
Update

Disclaimer: While I am an accountant, I am not your accountant. The information provided here is accurate and intended for guidance purposes, but individual circumstances vary. Always consult a qualified professional if you’re unsure, as mistakes can result in penalties.

1. Overlap Profits Explained

Overlap profits occur when a self-employed individual reports their income and expenses for an accounting period that doesn’t align with the tax year. Typically, these profits arise during the first three years of self-employment, due to HMRC's use of basis periods to ensure all sole traders are taxed on a consistent 12-month basis. This prevents one trader from gaining a tax advantage over another.

However, if a sole trader aligns their accounting period with the tax year, basis periods and overlap profits can be avoided altogether.

1.1 How Overlap Profits Arise

For example, a sole trader registers as self-employed on 1 July 2018 and chooses an accounting period ending 30 June each year. Their basis periods for the first three tax years would be:

2018/2019: 1 July 2018 – 5 April 2019
2019/2020: 1 July 2018 – 30 June 2019
2020/2021: 1 July 2019 – 30 June 2020

Profits from 1 July 2018 to 5 April 2019 are reported twice, in the 2018/2019 and 2019/2020 tax returns, meaning tax is paid twice on this period’s profits.

1.2 Overlap Profits from Changing Accounting Periods

Suppose the same sole trader changes their accounting period in 2021/2022 to end on 30 September, extending the period to 15 months. Overlap profits would occur for the period from 1 July 2019 to 30 June 2020.

1.3 Overlap Profits from Shortening Accounting Periods

Alternatively, the trader might shorten their accounting period to 31 May. The basis period for 2020/2021 remains 1 July 2019 – 30 June 2020, but in 2021/2022, overlap profits would occur for the month of June 2020.

2. How to Avoid Overlap Profit

To avoid overlap profits, the easiest solution is to choose an accounting period that matches the tax year (5 April or 31 March). This ensures your income and expenses align with the tax return period, simplifying reporting.

3. What is Overlap Relief?

Overlap relief allows self-employed individuals to claim back tax paid twice on overlap profits. It can be claimed when:

Changing accounting periods
Ceasing self-employment (e.g., when forming a limited company)

This relief ensures that over the lifetime of a business, the correct amount of tax and National Insurance is paid on profits.

4. HMRC Overlap Relief for Changing Accounting Periods

Overlap relief can be claimed as a deduction against taxable profits when the basis period of a tax year exceeds 12 months due to a change in accounting periods. However, the relief amount is limited to the number of days in the overlap period and the number of days by which the basis period exceeds 12 months.

For example, a sole trader with an accounting period ending 31 May changes it to 30 November. Overlap relief is limited to the excess days beyond 12 months in the new period.

5. How to Claim Overlap Relief

Overlap relief is one of HMRC’s income tax allowances and can be claimed on your self-assessment tax return. For example, in the 2017/2018 tax year, overlap relief might be claimed as a deduction against taxable profits, reducing the amount of tax owed.

5.1 How to Claim Overlap Relief on Cessation

When a business ceases trading, any remaining overlap relief can be claimed on the final self-employment tax return. For instance, if £4,109 of overlap profits remain, this amount can be deducted from the final declared profits.

6. Update

As part of HMRC’s Making Tax Digital initiative and efforts to simplify the tax system, proposed reforms would eliminate basis periods and prevent overlap profits from 6 April 2023. Learn more about the proposed basis period reforms [here].