Contractors' Questions: Which accounting year is best?

Contractor’s Question: For my Plan B, likely to be a sole trader business as I approach retirement, which accounting year should I choose?

Expert’s Answer: If you expect profits to rise steadily year by year, in the case of partnerships or sole traders, an accounting date early in the tax year, for instance April 30^th, might be best in the short term, because this will defer the payment of tax on your profit. However, it is important to consider what will happen when you retire. Any accounting date other than March 31^st will cause a bunching of your tax liabilities because all your profit that has not been assessed prior to your retirement will be assessed for your final year. There are a number of ways to mitigate the effect of this. You could plan to retire on or shortly after the accounting date, and allow “overlap relief” to reduce the burden. You could build up a reserve to meet the liability, or use the higher profit to permit an abnormally large pension contribution.

On the other hand if you expect to makes losses in your early years, an accounting date late in the tax year, for instance, March 31^st will ensure that you get tax relief for those losses are quickly as possible. You would then not be faced with the bunching problem on retirement, referred to above.

It will also be necessary to bear in mind the seasonality of your business. As part of the profit for your first period of trading could be taxed twice, it would be unfortunate if a poor choice of accounting date were to accelerate the tax on the profit of your first busy period. In these circumstances it might be preferable to run your first accounts to a date just short of your peak period.

As ever, it is important not to overlook commercial considerations. Your bank might want to see as a healthy a profit as you can manage and this desire could conflict with tax planning. A solution would be to choose a tax-efficient tax accounting date, and keep the bank manager happy (!) with quarterly management accounts.

The expert’s answer is an extract from The New Business Kit, a guide to financial, tax and accounting considerations for starting a successful business, by  The Low Tax Group, a chartered business advisory to contractors.