Guidance

HS222 How to calculate your taxable profits (2016)

Updated 6 April 2017

You must work out your taxable profits using:

  • cash basis accounting - you record income when you get it actually comes in and expenses when you pay them
  • traditional accounting (accruals basis) - you record income when you invoice your customers and expenses when you receive the bill

For more information on cash basis accounting see Cash basis. You’ll find more information on traditional accounting below.

Records

You must keep records of your business transactions. Whatever basis you use, your records must include:

  • all your sales and takings (income)
  • all your purchases and expenses

You normally need other records too.

Some businesses can use can use a flat rate (simplified expenses) instead of the actual expenses to work out:

  • business costs for vehicles
  • business use of home or private use of business premises (not both)

For more information on records see business records if you’re self-employed

For more information on simplified expenses see simplified expenses if you’re self-employed.

Accounting periods (period of account)

Your accounting period is the period your accounts cover. If you’re a new business, your accounting period starts on the date your business started. If you are not a new business your accounting period starts on the day after the end of your previous accounting period. For example, if you made your accounts up to 5 April 2015, your new accounting period starts 6 April 2015.

Your accounting date is the last day of your accounting period. You choose your accounting date. Normally you make your accounts up to the same date each year. If you change your accounting date special rules apply. You will find information on change of accounting date below.

If you’re a new business you may find you tax is easier if you choose 5 April as your accounting date as that is the end of the tax year, or 31 March, 1, 2, 3, or 4 April.

Entering cash basis

If you have an existing business and you are switching over to cash basis, you might have to make some one-off adjustments to your tax in this period. The table below shows if you need to make an adjustment, and if so, how to make it.

When you need to make an adjustment How to do the one-off adjustment
If your customers owed you money at your accounting date last year, and you paid tax on that amount in that tax year, and your customers have paid you in this accounting period. Take away the amounts owed to you from your total cash basis turnover for this accounting period.
If you owed money to your suppliers at your accounting date last year, and you received tax relief on that amount in that tax year, but you did not pay your supplier until this accounting period. Take away the amounts owed to your suppliers from your total cash basis expenses for this accounting period.
If you had a stock of items at your accounting date last year, but you did not get tax relief for the cost. Add the cost of those items of stock to your cash basis expenses for this accounting period.
If you received money from your customers in your accounting period last year (for example, payments made in advance of work done) that you did not pay tax on. Add the amounts that your customers paid you (but you were not taxed on) to your total cash basis turnover for this accounting period.
If you paid money in advance for certain items in your accounting period last year (for example, a subscription, or a deposit) that you did not get tax relief for. Add the amounts that you paid to your suppliers (which you did not get tax relief for) to your total cash basis expenses for this accounting period.
If you paid in full for items of equipment, and you had a balance of capital allowances (see ‘Capital allowances and balancing charges’ below) still to claim on that equipment, at the end of your accounting period last year. Add the balance of capital allowances you can still claim to your total cash basis expenses for this accounting period.
If you partly paid for items of equipment (for example, by instalments) by the end of your accounting period last year, but you had claimed a different amount. If the amount you partly paid was more than the capital allowances claimed, we treat the difference as an expense (increasing your total cash basis expenses) as a transitional adjustment for this accounting period. If the amount you partly paid was less than the capital allowances claimed, we treat the difference as turnover (increasing your total cash basis turnover) as a transitional adjustment for this accounting period.

If this is your first tax period with self-employment income, you will not need to make any adjustments.

Leaving cash basis

If you have an existing business and you are switching over from cash basis to traditional accounting you need to work out an overall adjustment. This can be either:

  • a negative adjustment that is allowed as an expense in this accounting period
  • a positive adjustment that is income of your business (adjustment income) and is normally taxed over 6 years starting this year

Working sheet 1 tells you how to work out the adjustment and what to do with it.

Traditional accounting (accruals basis)

The following notes aren’t a complete guide. If you need more information on traditional accounting contact your tax adviser.

Records

The records you must keep include:

  • all your sales and takings (income)
  • all your purchases and expenses

The records you may include:

  • business assets you’ve bought (for example, stock or equipment)
  • value of stock and work in progress at the end of your accounting period
  • details of payments to employees (for example, wages, expenses or benefits)
  • business vehicle and travel costs; business miles travelled if you use simplified expenses
  • interest from any bank or building society accounts
  • other money coming in, such as, money you invest in your business

Expenses

Only include business expenses in your accounts if they belong to that accounting period. If an expense covers more than one accounting period, you’ll need to spread that cost. For example, if your rent is payable 12 months’ in advance halfway through your accounting period, include half of the payment payable as an expense in your accounts for this year. Include the other half in your accounts for next year.

Cost of Sales

This is the cost of any raw materials and goods bought for resale which you used during your accounting period. Don’t include items received in your last accounting period that you paid for in this accounting period.

Use Working sheet 2 to help you work out how much you can claim.

Allowable business expenses: cash basis and traditional accounting

The table below lists the main categories of expenses that businesses have. Not all expenses are allowed for tax. If you include all of the expense when you work out your profit you must add the non-allowable expenses or part expenses to the profit.

Category Allowable expenses Non-allowable expenses
Cost of goods that you are going to sell or use in providing a service. Use the working sheet above if you use traditional accounting.
Amount paid for goods bought for resale, if you use cash basis.
Cost of goods or materials bought for private use.
Construction industry – payments to subcontractors. Construction industry subcontractor’s payments (before taking off any tax). Payments for non-business work.
Wages, salaries and other staff costs. Wages, salaries, bonuses, pensions, benefits for staff or employees, employers’ National Insurance contributions, Agency fees, and so on. Own wages, drawings, pension payments, National Insurance contributions if included in expenses.
Payments for non-business work.
Car, van and travel expenses. Motoring costs such as car and van insurance, repairs, servicing, fuel, hire charges, vehicle licence fees,
AA/RAC membership or the flat rate amount.
If you use cash basis, the cost of vehicles other than cars.
Train, bus, air and taxi fares; hotel room costs.
Meals on overnight business trips.
Non-business (private use proportion of) motoring costs.
Fines.
The cost of buying vehicles or, if you use cash basis, the cost of cars.
Travel costs between home and business.
Other meals
Rent, rates, power and insurance costs. Rent for business premises, business and water rates, light, heat, power, property insurance, security.
If you use your home for business, the business proportion of the expenses or flat rate amount.
Repairs of non-business parts of premises or equipment.
Costs of buying, improving or altering premises.
Cost of equipment and initial cost of tools, if you use traditional accounting.
Phone, fax, stationery and other office costs. Phone, mobile, internet, email and fax running costs. Postage, stationery, printing, small office equipment and computer software costs.
If you use cash basis, the cost of equipment.
Non-business or private use proportion of expenses. (Ignore private use of telephone and broadband service if this is insignificant.) New phone, fax, computer hardware or other equipment costs if you use traditional accounting.
Advertising and business entertainment costs. Advertising in newspapers, directories and so on, mailshots, free samples, website costs. Entertaining clients, suppliers and customers. Hospitality at events.
Interest on bank and other business loans. Interest on bank and other business loans. Alternative finance payments.
If you use cash basis, the maximum amount you can claim for interest and incidental costs of obtaining loan finance is £500.
Repayment of the loans or overdrafts, or finance arrangements.
Bank, credit card and other financial charges. Bank, overdraft and credit card charges, hire purchase interest and leasing payments. Alternative finance payments.
If you use cash basis the maximum amount you can claim for interest and incidental costs of obtaining loan finance is £500.
Repayment of the loan, overdraft or finance arrangements.
Irrecoverable debts written off. Amounts included in turnover but unpaid and written off (due to being unrecoverable).
Not relevant if you use cash basis.
Debts not included in turnover. Debts relating to fixed assets. General bad debts.
Accountancy, legal and other professional fees. Accountants, solicitors, surveyors, architects and other professional fees.
Professional indemnity insurance premiums.
Legal costs of buying property. Legal costs of buying equipment if you use traditional accounting.
Costs of settling tax disputes.
Fines for breaking the law.
Depreciation and loss/profit on sale of assets. See ‘Capital allowances and balancing charges’ below. Depreciation of equipment, cars and so on.
Losses (minus any profits) on sales of assets (traditional accounting).
on sale of cars (cash basis).
Other business expenses Trade or professional journals and subscriptions; other sundry business running expenses not included elsewhere. Payments to clubs, charities, political parties and so on.
Non-business part of any expenses. Cost of ordinary clothing.

Your basis period

You’ll pay tax on the profits for your basis period for the tax year. After the first year or two in business, your basis period is the 12-month period you use for your accounts (except if you change your accounting date or ceased).

Use the following rules to help you work out your basis period. If you are a partner see Partners’ trading or professional profits below. Partnerships do not have basis periods.

Business started in 2013 to 2014 or earlier years

If you started the business before 6 April 2014 your basis period is the 12 months to your accounting date in 2015 to 2016 (unless you ceased the business or changed accounting date during 2015 to 2016, see ‘Cessations’ or ‘Changes of your accounting date’ below). eg, you start your business on 1 January 2014 and you make up your accounts to 31 December 2014 and 31 December 2015, your basis period for 2015 to 2016 is 1 January 2015 to 31 December 2015.

Business started in 2014 to 2015

If you started the business during the period 6 April 2014 to 5 April 2015, your basis period is (unless you’ve ceased the business or changed accounting date during 2015 to 2016) is:

  • the 12 months to your accounting date, if your accounting date in 2015 to 2016 is 12 months or more after the date on which you started the business
  • the 12 months beginning on the date you started, if your accounting date in 2015 to 2016 is less than 12 months after the date on which you started the business
  • 6 April 2015 to 5 April 2016, if you do not have an accounting date in 2015 to 2016

Business started in 2015 to 2016

If you started the business during the period 6 April 2015 to 5 April 2016, your basis period is from the date you started to 5 April 2016. For example, if you started the business on 1 July 2015, your basis period is 1 July 2015 to 5 April 2016.

If your businesses started in the period 1 to 5 April, we will treat the profit for year 1 as nil. This won’t affect anything else that depends upon the date, or tax year, your business starts.

Cessations

If your business ceased during 2015 to 2016, your basis period is between the end of the basis period for 2014 to 2015 and the date on which your business ceased. For example, if your basis period for 2014 to 2015 ended on 30 April 2014 and you stopped trading on 31 December 2015, your 2015 to 2016 basis period is 1 May 2014 to 31 December 2015.

If your business started and ceased in 2015 to 2016 your basis period is the period of your business.

Changes of accounting date

There is a change of accounting date if you:

  • made up your accounts to a date different from the date used last year
  • are going to make up your accounts for more than 12 months, and no accounting date falls in the 2015 to 2016 tax year
  • changed your accounting date last year, but this was not agreed by us, and you have made your accounts up to the same date this year (if you changed back to your old date, this is not a change of accounting date)

Your basis period – if you change your accounting date

If your accounting date in 2015 to 2016 is more than 12 months after the end of the basis period for 2014 to 2015, your basis period is the period between the end of the basis period for 2014 to 2015 and the new accounting date. For example, your basis period for 2014 to 2015 ended on 31 May 2014 and the new accounting date is 31 August 2015 – your basis period is the 15-month period 1 June 2014 to 31 August 2015 – see ‘overlap relief’ below.

If your accounting date in 2015 to 2016 is less than 12 months after the end of the basis period for 2014 to 2015, your basis period is the 12 months ending on the new accounting date – for example, your basis period for 2014 to 2015 ended on 31 December 2014 and the new accounting date is 31 July 2015 – your basis period is the 12-month period 1 August 2014 to 31 July 2015, see ‘Overlap profits’, below.

If your new accounting date 31 March or 1, 2, 3 or 4 April, see Accounting dates in the period 31 March to 4 April below.

Conditions for change of accounting date

If you want to change your accounting date from year 4 onwards:

  • you must tell us about the change in your tax return, and send it back by the relevant filing date
  • the first accounts, to the new accounting date, must not be more than 18 months
  • if you changed accounting date in any of the previous 5 tax years, you must tell us why you’ve made the change. This change must be for genuine commercial reasons. Obtaining a tax advantage is not a commercial reason

What to do if your basis period is not the same as your period of account

If your basis period is different from your accounting period or periods, you must work out your profit by adding together or dividing profits or losses for the periods for which you’ve accounts. For example, your business started on 6 April 2015 and your basis period is the 12 months to 5 April 2016. Your accounts are for the 3 months to 30 June 2015 (profit £4,500) and the 12 months to 30 June 2016 (profit £24,000). Your basis period covers 3 months of your 2014 accounts and 9 months of your 2015 accounts.

The profit for the basis period will be: £4,500 + (280/365 × £24,000) = £22,910.

We’ve used days but you can use any reasonable basis, for example months or weeks. You must use the same basis consistently for the trade.

Accounting dates in the period 31 March and 4 April

The basis period for the tax year in which a business starts (year 1) usually ends on 5 April. However, if a new business chooses an accounting date of 31 March or 1, 2, 3 or 4 April, the accounts are treated (unless you elect otherwise) as being made up to 5 April and there is no need to add in any profits from the next accounting period if those profits are taxed in the following year. There is no overlap profit (see below) and no overlap period.

You may also treat a change of accounting date where the new date is 31 March or 1, 2, 3 or 4 April as though it was a change to 5 April. All overlap profits are deductible in the year that the change takes effect. Talk to your tax adviser if you need more help.

Overlap profits

You may find that your basis period for 2015 to 2016 overlaps with the basis period for 2014 to 2015. Overlaps can happen in the first 3 years after a business starts up or in a year in which there is a change of basis period because of a change of accounting date. For example, if your business started on 1 January 2015 and your first accounts are for the 12 months to 31 December 2015, your basis periods are:

  • 2014 to 2015, 1 January 2015 to 5 April 2015
  • 2015 to 2016, 1 January 2015 to 31 December 2015

The period of overlap is 1 January 2015 to 5 April 2015. So, if the profit for the 12 months to 31 December 2015 is £12,000, the overlap profit is (96/365 × £12,000) = £3,156 (over 96 days).

If your basis periods overlap, keep a record of the overlap profit and the overlap period. Add in any overlap profit and period that you’ve carried forward and not yet claimed as Overlap Relief.

Overlap Relief used this year

Box 69 on the ‘Self-employment (full)’ pages (or box 13 of the ‘Partnership’ pages)

You must take off (as Overlap Relief) overlap profits which arose in earlier years when working out your taxable business profits for 2015 to 2016 if:

  • you sold or closed down your business in 2015 to 2016. Put all overlap profits brought forward in box 69 on page SEF 4 of your ‘Self-employment (full)’ pages (or box 13 if you are filling in the ‘Partnership’ pages)
  • your basis period for 2015 to 2016 is more than 12 months long because you changed your accounting date. The amount of overlap profits you use as overlap relief is in proportion to the length of your basis period that exceeds 12 months and the length of your overlap period from earlier years

For example, you’ve overlap profits of £5,000 (over 5 months) from an earlier year. You change your accounting date. Your basis period is 14 months. The relief is in proportion to the number of months by which the basis period exceeds 12 months (that is, 2 months) and the length of the overlap period (that is, 5 months).

So, the overlap relief is:

2/5 × £5,000 = £2,000

The balance of overlap profit, £3,000 (over 3 months), is carried forward. You can claim this as Overlap Relief in a later year.

Capital allowances and balancing charges

When working out your business profits don’t take off the cost of buying or improving items such as a car, equipment or other tools that you use in your business or the depreciation or any other losses which arise when you sell them. Instead, you can claim tax allowances called capital allowances. You take off the allowances from your profit to find your taxable profits, or add them to your losses to get your allowable loss.

Usually, anything you use that has a useful economic life of at least 2 years may qualify for capital allowances.

Capital allowances do not apply to items that you buy and sell as part of your trade; these items are included in business expenses.

If you have claimed capital allowances, an adjustment, known as a balancing charge, may arise when you sell an asset, give it away or stop using it in your business. We add the balancing charge to your taxable profits, or take them off your losses, in the year they occur.

If you are using cash basis, you can only claim capital allowances on cars. The cost of all other equipment and vehicles is an allowable expense in working out your business profits.

For more information see Capital allowances and balancing charges: HS252 Self Assessment helpsheet.

Losses – terminal loss relief

If your business ceased in 2015 to 2016 and you made a loss in your final 12 months of trading, you can claim terminal loss relief against your profits from the same business.

Your terminal loss must be set against any profits (after deducting losses brought forward) from the same business taxed in 2015 to 2016. If any terminal loss remains it must be set against the profits of the same business taxed in the 3 prior years. Start with the latest year.

Put the amount of terminal loss relief you are claiming against your 2015 to 2016 profits in box 74 on page SEF 4 of the ‘Self-employment (full)’ pages or box 17 on the ‘Partnership’ pages. This is in addition to any other losses you are bringing forward from earlier years.

Put the total amount of terminal loss relief for the 3 prior years in box 79 on page SEF 4 of the ‘Self-employment (full)’ pages or box 23 on the ‘Partnership’ pages. Give details of the amount for each year in box 103 ‘Any other information’, on your ‘Self-employment (full)’ pages or in box 19 ‘Any other information’, on your tax return.

Make sure you that you don’t count the same loss twice.

For more information on terminal losses and how to calculate your terminal loss see Losses: HS227 Self Assessment helpsheet.

Partners’ trading or professional profits

The basis period and overlap rules apply to your share of the partnership’s trading and professional profits (or losses) as if you’d got the profit or loss from a trade you carried on as a sole trader.

This starts on the date you became a partner (unless you’d carried on the same business yourself), and stops on the date when you ceased being a partner (unless you carried on the same business yourself, afterwards).

Example 6

The partnership started trading on 1 October 2013 and makes up its account to 30 September. You stopped being a partner on 31 December 2015.

Your share of trading profits is:

year ended 30 September 2014 £12,000
year ended 30 September 2015 (A) £18,000
year ended 30 September 2016 (B) £7,000

Your basis periods and the Overlap Relief are as follows:

2013 to 2014: 1 October 2013 to 5 April 2014 profits £6,000
2014 to 2015: 1 October 2013 to 30 September 2014 profits £12,000
(Overlap period 6 months: overlap profits) (C) £6,000
2014 to 2015: 1 October 2014 to 31 December 2015 profits (A) + (B) £25,000
Minus  
Overlap Relief (C) £6,000
Taxable profit (D) £19,000

In the 2015 to 2016 ‘Partnership’ pages, enter £18,000 in box 8, £7,000 in box 9, £6,000 in box 13 and £19,000 in boxes 16, 18 and 20.

If you are unsure how the basis rules apply to you as a partner, ask your tax adviser for help.

Other partnership income

If the partnership carried on a trade or profession in 2015 to 2016 the basis period depends on whether the partnership income had tax taken off.

You are treated as a ‘notional’ business (sole trader) for any untaxed partnership income. The same basis period and overlap rules applied to your share of the partnership’s trading or professional profits apply to the ‘notional’ business.

For this purpose you treat the ‘notional’ business as commencing on the date you became a partner and ceasing on the date you stopped being a partner.

If you are entitled to overlap relief from your ‘notional’ business, it is first set against any other untaxed income (regardless of the source it came from) and any balance given as a deduction against any other income of that year. For your share of the partnership’s ‘taxed income’, your basis period is the period 6 April 2014 to 5 April 2016.

If the partnership did not carry on a trade or profession in 2014 to 2015, the basis period for both ‘untaxed’ and ‘taxed’ income is 6 April 2015 to 5 April 2016.

Contact

Online forms, phone numbers and addresses for advice on Self Assessment.