Partnerships

Tax Issues for Partnerships

The rules allow businesses a free choice of accounting date. Under the current year basis, the taxable profit for a particular tax year is determined by the accounts that end in that year.
Thus, for 2006/07 tax, accounting dates will vary between 6 April 2006 and 5 April 2007. So what is the best date to choose?
Sometimes, compelling commercial reasons relating to the nature of the trade will dictate the most appropriate accounting date. Otherwise (as in many tax matters), there is no easy answer - it all depends on the particular circumstances. There are several basic considerations:

Overlap Relief

The system is designed so that, over the life of a business, tax is paid on no more and no less than the cumulative profits of the business. However, unless your accounting date falls between 31 March and 5 April (inclusive), there will be some element of double counting, or overlap, in the first full tax year on the current year basis.
Overlap relief will be held in reserve for use when the business ceases (or on an interim change of accounting date). One concern is that, because of inflation, overlap relief will be worth less in future years than it is at present.

Bunching of terminal profits

The converse of the overlap situation is the 'bunching' effect of profits when a business ceases. The assessment for the final tax year will be based on the profits right back to the accounting date in the previous tax year. The earlier in the tax year the accounting date falls, the longer will be the period of account relating to the final assessment.
Thus a cessation date of, say, 31 December means that the final tax assessment will be based on a period varying in length between 9 months (5 April accounting date) and 21 months (6 April accounting date). This effect may be lessened to some extent by overlap relief, but the overall distortion is illustrated in the example set out below.

Partnerships

Partners are each deemed for tax to have an individual business so the points already mentioned for new businesses and those ceasing apply equally to partners joining or leaving a continuing partnership.

Pattern of profits

If profits do not vary significantly from one year to the next, the accounting date will not affect the assessable profit for each tax year.
Where profits show a trend, the rule of thumb is that (all other things being equal) it is beneficial to have an accounting date early in the tax year if profits are rising, and late in the year if profits are falling.

Of course, the total assessable profits are the same in each case, and equal to the total profits derived from the accounts. The variations arise because of timing differences in the assessment of tax.
These assessment timing differences will obviously affect the tax payable on the normal payment dates of 31 January and 31 July each year. It is therefore vital to consider the implications of these cashflow differences in assessing the advantages and disadvantages of particular accounting dates.

Conclusion

Using a 5 April (31 March) accounting date leads to the simplest application of the current year basis of assessment. However, it does mean that the timetable for tax payments and returns is very tight, and there is therefore an increased risk of incurring penalties. Also there is now less time to allow for tax and business planning relating to tax issues.

If you expect your profits to show an overall upward trend, there are clearly cash flow advantages in having an accounting date at or shortly after the beginning of the tax year. In these circumstances, it is important to ensure that you make proper provision for the increased liability that will occur when the business ceases.