How do I work out my taxable profits?
There are many steps to working out your taxable profits. We take you through the process.
Taxable profits are usually based on the profits shown by your business accounts, after they have been adjusted to comply with the tax rules. We explain how to prepare business accounts and how to make adjustments for tax purposes later on this page.
However since 6 April 2017 there are two situations where these calculations may not be necessary and this is due to the introduction of the trading allowance. The situations are:
(a) if the total income in your basis period for the tax year is less than the trading allowance and you decide to use the allowance then there is no taxable profit for the business in that tax year, or
(b) if you decide to claim a round sum amount equal to the trading allowance for your business expenses instead of the actual business expenses you have incurred in your basis period for the tax year, then the taxable profit is simply the excess of the total income over the trading allowance in that tax year.
However, you cannot create a loss if your trading income is less than the trading allowance.
This is explained in more detail on our What is the trading allowance? page.
Your total income, which is also known as your gross income, is all your business income in the accounting period. This is also called turnover or sales. This information should form part of your day-to-day business records and so should be fairly easy to calculate. Most small businesses or hobby traders will record their income and expenses on a cash basis and so for most people, the gross income will be the amount of sales income received in the accounting period.
This is the period for which you will be charged tax in a particular tax year. Usually, for a continuing business this is the 12 month accounting period that ends within that tax year.
The tax year is a 12 month period which runs from 6 April to the following 5 April. For example the 2019/20 tax year runs from 6 April 2019 to 5 April 2020.
Normally accounts are prepared to the same date in each year (the accounting date), so you usually choose a date that is convenient for you. You can have any day in the year as your accounting date although from a tax point of view, the easiest date to choose is 5 April, but any date from 31 March to 5 April inclusive will be treated as 5 April to make things as easy for you as possible.
If you make up your accounts to 31 December each year, this is your accounting date and the 12 months to 31 December is your accounting period.
If you start your business on 1 July your first accounting period will be only six months long, and then subsequent accounting periods will be 12 months each.
Trevor makes up accounts to 31 October each year. His basis period for 2019/20 is the year ended 31 October 2019. This means that the tax Trevor will pay for the 2019/20 tax year is the tax on his taxable profits for the basis period 1 November 2018 – 31 October 2019.
For the first tax year, your basis period is always the period from the date you started trading until the following 5 April.
Remember that if your accounting date falls between 31 March and 5 April inclusive, this will be treated as 5 April for these purposes.
Gunther starts trading on 1 July 2019. His basis period for the 2019/20 tax year is the period from 1 July 2019 to 5 April 2020.
For the second tax year that you are self-employed you may fall into one of three different categories:
- If you have prepared a set of accounts for at least 12 months that end in that second tax year, then the basis period for that tax year is the 12 months ending on the accounting date.
George starts trading on 1 September 2018. He draws up accounts to 31 December 2019 and to the same date each year after that.
The basis period for his first year (2018/19) is the period from 1 September 2018 to 5 April 2019. The basis period for his second year (2019/20 tax year) is the year from 1 January 2019 to 31 December 2019. The basis period for his third year is the year to 31 December 2020.
You will see that to arrive at these figures George will have to split the figures for his 16 month period of accounts. This is done on a strict time basis. For example, if George’s accounts for the 16 month period to 31 December 2019 show a profit of £16,000, then it is assumed he made a profit of £1,000 each month evenly over the period, so for the basis period from 1 September 2018 to 5 April 2019, he would be assumed to have profits of £7,000 – equivalent to profits for seven months.
- You may have no accounts that actually end in the tax year: if that is the case, the basis period is from 6 April to the following 5 April.
Alexander starts trading on 1 February 2018 and draws up accounts to 30 April 2019 and to the same date each year after that. Therefore his first set of accounts end in the 2019/20 tax year and so he does not have a set of accounts that end in the 2018/19 tax year, which is his second tax year of trading.
The basis period for his first year (2017/18) is the period from 1 February 2018 to 5 April 2018. The basis period for his second year (2018/19) is the period from 6 April 2018 to 5 April 2019. The basis period for his third year is the twelve months to 30 April 2019.
- You may prepare a set of accounts that end in the tax year, but they are less than 12 months long. In that case, the basis period is your first 12 months of trading.
Louis starts trading on 1 January 2018 and draws up his first set of accounts for a six month period to 30 June 2018 and to the same date each year after that.
The basis period for his first year (2017/18) is the period from 1 January 2018 to 5 April 2018.The basis period for his second year (2018/19) is from 1 January 2018 to 31 December 2018. The basis period for his third year is the year to 30 June 2019.
You will notice that in the examples above some of the profits may be taxed twice in different tax years, we explain how this works in the section, I seem to be taxed twice on some profits. Is that right?.
This final basis period starts immediately after the previous period ends and stops on your final day of trading.
Yasmine has traded for many years making accounts up to 31 October. Yasmine ceases trading on 31 August 2019, which is in the 2019/20 tax year.
Yasmine’s accounts for the year to 31 October 2018 would form her basis period for the tax year 2018/19. Yasmine’s final tax year of trading is 2019/20 and her basis period is the period from 1 November 2018 to 31 August 2019.
Yasmine would be able to deduct any overlap relief that was still being carried forward when she ceased trading.
You need to prepare accounts so you can work out what profits or losses you have made from your self-employment. You do this from your business records. Your accounts should show all of the income and expenses from your business for the period of the accounts. After that you can decide whether the expenses are allowable for tax purposes or not.
Historically, this was the usual way that accounts were prepared in the UK. In general terms this means that all income earned and all expenses incurred during the accounting period are included in the accounts, whether they are paid or not.
For example, if you invoice a customer on 31 December 2019 and draw up accounts to 31 December 2019, this invoice would be included, whether the customer had paid it or not.
Similarly, if you paid your annual insurance bill on 1 July 2019 to cover the period from 1 July 2019 to 30 June 2020, you would only include half of the cost in the accounts to 31 December 2019 even though you had paid the full amount; the other half would be included in the accounts for the following year as a prepayment.
There is more information on the accruals basis including how to move from the accruals basis to the cash basis and vice versa on our What is the cash basis? page.
Whereas the accruals basis looks at income earned and expenses incurred, the cash basis looks at income actually received and expenses actually paid in the accounting period.
If you meet certain criteria, you can choose to use the cash basis instead of the accruals basis.
You can read more about this on our page What is the cash basis?.
Below is an example of what a typical profit and loss account may look like, but if your accounts look slightly different to this that is fine as long as you have included all the income (sales) less any business expenses (costs) so you can calculate your business profit.
Profit and loss account for the year ended 5 April 2019
Tax year 2018/19
|Sales (turnover or income)||15,000|
|Less cost of sales:|
|Less other expenses|
|Travel – mileage||400|
|Working at home||120|
|Net taxable profit||6,505|
I have prepared my accounts and decided which expenses are not allowable. What do I do next?
You take the profit per your accounts (£6,505 in the above example) and add to it any business expenses that are not allowable for tax purposes. This is because you may incur expenses that reduce your profit in your accounts but which HM Revenue & Customs (HMRC) do not allow you to deduct for tax purposes. You must therefore add them back in so that you pay tax on them.
Bernard’s accounts for the year to 31 March 2020 show a profit of £17,300. The accounts include all of his motoring expenses of £12,000, but Bernard estimates that only 60% of these costs are actually business costs.
|Profit per accounts||£17,300|
|Add: private motoring expenses||£4,800 (40% of £12,000)|
|Adjusted taxable profits||£22,100|
Some expenditure will be treated as capital expenditure rather than a revenue or trading expense. An item will generally be a capital expense rather than a revenue expense if it is an item you need for your business and it is likely to have an enduring benefit. There are some exceptions to this.
If you are using the accruals basis you cannot deduct capital expenditure from your trading profits. Instead you may be able to claim capital allowances for that expenditure.
Once calculated, capital allowances are treated as a trading expense and are deducted from the adjusted profits as illustrated in the example below. You should note that a deduction of capital allowances may create a loss for tax purposes or increase a loss.
Continuing the example of Bernard from above: Bernard bought a new machine in January 2020 for £2,500. The machine will qualify for 100% capital allowances (annual investment allowance).
Bernard’s taxable profits become:
|Adjusted profits (from above)||
|Less: capital allowances||£2,500|
See our capital allowances page for more information on calculating capital allowances.
Once you have calculated the taxable profits in this way you will need to work out which tax year the profits will be taxed in by following the basis period rules explained above.
The tax system operates so that overall all business profits are only taxed once but, as you can see from the examples above, sometimes at the start of a business profits are taxed more than once. These profits that are taxed twice are called overlap profits.
Consider the Louis example above.
In year one (2017/18) he is taxed on the profits from 1 January 2018 to 5 April 2018.
In year two (2018/19) he is taxed on the profits from 1 January 2018 to 31 December 2018.
In year three (2019/20) he is taxed on the profits from 1 July 2018 to 30 June 2019.
You will see that in year two he is taxed on the profits from 1 January 2018 to 5 April 2018 that were already taxed in year one.
In year three he is taxed on the profits from 1 July 2018 to 31 December 2018 that were already taxed in year two.
If we assume that Louis’s taxable profits for the six month period to 30 June 2018 were £6,000 and his profits for the year to 30 June 2019 were £18,000, then his taxable profits and overlap profits would be as follows:
|Tax year||Taxable profits||Overlap profits|
|2017/18||£3,000 (three months)||nil|
|2018/19||£15,000 (12 months being six months to 30 June 2018 plus six months to 31 December 2018 so £6,000 + £9,000)||£3,000 (3 months to 5 April 2018)|
|2019/20||£18,000 (12 months to 30 June 2019)||£9,000 (6 months)|
Total overlap profits are £12,000.
As you should only be taxed once on income, you can use these overlap profits at a later date to reduce the tax you pay.
You can use overlap profits either when you cease to trade or if you change your accounting date to a date closer to the end of the tax year, that is 5 April. See below for an explanation of how each of these works.
You will need to keep a note of the amount of overlap profit you have and what number of months it relates to. You carry your overlap profit forward on your tax return until you are able to use it.
It is possible to change your accounting date for tax purposes but you will need to explain to HMRC in your tax return why the change is necessary. They may not accept your explanation in which case you will have to keep your existing date.
However, if you have a reasonable argument it is likely to be accepted. For example, you have two businesses and you want the same accounting date for each. You cannot just keep changing the date each year because it is convenient to do so.
If you want the change to be temporary – you can ignore it for tax purposes. Otherwise you will be treated as having changed your accounting date if any of the circumstances described below apply:
You have made up accounts to a date different from that used for your tax in the previous year
You intend to draw up a set of accounts for more than 12 months so that no accounting date falls into the current tax year
If you changed your accounting date last year but this was not accepted by HMRC and you are using the same date again
Changing your accounting date will mean that you will have a new basis period for your taxable profits. See the section below for how this is calculated.
If you change your accounting date you will need to work out your new basis period using the following rules:
- If your new accounting date in 2019/20 is more than 12 months after the end of your basis period for the previous year (2018/19), your new basis period will be from the end of that basis period to your new accounting date.
Susan has a basis period in 2018/19 that ended on 30 June 2018. She decides her new accounting date will be 30 September 2019. Her basis period for 2019/20 is the 15 months from 1 July 2018 to 30 September 2019. If Susan has carried forward any overlap profits, then at this time she can use overlap relief equivalent to three months of profits to reduce the tax she has to pay for the 2019/20 tax year. If she was carrying forward overlap profits of £4,000 that equated to four months profits, then she would use overlap profits of £3,000 now and still carry forward £1,000.
- If your accounting date in 2019/20 is less than 12 months after the end of your basis period for the previous year to 2018/19 your new basis period will be 12 months ending on the new accounting date.
Tom has a basis period for 2018/19 that ended on 30 September 2018. His new accounting date is 30 June 2019. His basis period for 2019/20 will be the 12 months to 30 June 2019. He is creating a further three months of overlap profits that will be carried forward.
If you have changed accounting date and your basis period is more than 12 months, you can use your overlap profits to reduce the basis period to 12 months – see the example Susan above.
Further example on use of overlap profit
Mae has unused overlap profit of £6,000 which came about because six months of profits overlapped when she started her business. Mae then changed her accounting date and her new basis period for 2019/20 is 15 months. She can only be taxed on 12 months’ profits.
Mae has six months overlap relief available and she needs to reduce the 15-month basis period to 12 months so she uses three months of her overlap relief up.
Overlap relief used
3/6 x £6,000 = £3,000
Mae’s profits for 2019/20, which are based on a 15-month basis period will be reduced by £3,000 and she still has three months overlap profits to carry forward.
If you wish to find more information on changing your accounting date, see the guidance contained in the HS222 How to calculate your taxable profits factsheet.
How do I get relief for overlap profits when I cease trading?
Any previously unrelieved overlap profits are deducted from your profits in the last tax year.
Louis is carrying forward overlap profits of £12,000. He makes up his last set of accounts for the year to 30 June 2019 that show a profit of £28,000.
Louis ceased trading on 30 June 2019, that is in the tax year 2019/20. If he had not ceased trading he would have been assessed to tax on profits of £28,000. But he can deduct his overlap profits from his taxable profits for the year to 30 June 2019 because he has stopped trading. His assessable profits for 2019/20 become £16,000 (£28,000 less overlap profits of £12,000).
Where can I find more information on preparing my accounts for my tax return?
Our guide to self-employment is intended to supplement the material in this section. We wrote this guide to help advisers (non-tax) who advise low-income self-employed individuals and also for self-employed people who want more detailed information in one accessible place. The guide explains the less common tax rules and contains more detailed information including examples of accounts prepared using the accruals basis and the cash basis and also a case study showing how to prepare accounts and what to include on your tax return using the cash basis.