INTM165060 - UK residents with foreign income or gains: income tax: Overlap profits

From 2024-25 profits are assessed on the basis of profits earned in the tax year and overlap relief is abolished. This guidance therefore only applies up to 2023-24.

Where any new source of foreign income arose on or before 5 April 1994, application of the old commencement provisions means that income from the source will, in the early years, be assessed to UK Income Tax more than once. This is so for any source of income chargeable under Case V, when ICTA88/S66 applied, and also where the income represented elements of profits assessable under Case I or II, when the basis periods on commencement were provided by ICTA88/S61 and ICTA88/S62.

Similarly, under the current year basis of assessment rules introduced by FA94, basis periods for any trade, profession or vocation may overlap with the result that profits or gains are included in the computation for two successive years of assessment. Such profits are `overlap profits' and arise whenever a trade, profession or vocation is newly set up and commenced on or after 6 April 1994, and also when a business changes its accounting date to a date earlier in the tax year.

ICTA88/S804 (now TIOPA10/S22 & 24) enables additional tax credit relief to be allowed whenever the same income is being charged to UK tax for more than one year of assessment.

Claims for relief under Section 22 should be made on or before the fifth anniversary of 31 January next following the end of the year of assessment (years 1996-97 onwards, now TIOPA10/S23) or, if later, the 31 January next following the year of assessment in which the foreign tax is paid (for claims made on or after 21 March 2000 only (see ICTA88/S806(1) as amended by Finance Act 2000).)

The same principles apply where there is an overlap period for any other reason.

Foreign Tax Credit Relief (FTCR) for the Transition Year (2023/24)

Where FTCR is allowed in respect of foreign tax payable during the transition year, this will need to be spread in the same ratio in which any transition profits are spread across up to five tax years.   

Based on the same income principle, FTCR for foreign tax on profits must be set against the UK tax on those same profits. If those profits are spread over a number of tax years, FTCR should be spread on the same basis.   

Prior to 2023-24, under the current year basis of assessment rules introduced by FA94, when a business first commenced, the basis periods may have overlapped with the result that profits or gains were included in the computation for two successive years of assessment. Similarly, per s22 TIOPA 2010, FTCR will have been given in respect of the same foreign tax for the same periods.   

Under the changes to the basis period rules in Finance Act 2022 (FA22), when the transition rules are triggered (per s205/220, or deemed as such by Sch 1 FA22), overlap relief is provided to the extent that profits were taxed in more than one period. At the same time, the FTCR allowed in respect of foreign tax and set against UK tax on overlap profits will need to be clawed back under s24 TIOPA 2010. 

In carrying out the computations, the transition part profits less the overlap relief is calculated, and the UK profits are spread over five years (with a potential election to bring the profits forward). The FTCR is computed in respect of the foreign tax payable over the transition period, and the FTCR already given in the overlap period is clawed back and set against the transition part FTCR. The net transition part FTCR is set against UK tax on the spread transition profits on the same basis as the profits are spread.  

As the transition profits are spread over five years (and the UK tax likewise spread over five years), then the FTCR and the clawed back FTCR will likewise be spread on the same basis. This will be in line with the same income principle as explained above.  

In cases where the overlap profits exceed the transition period profits, see the guidance in BIM81290 

If the clawed back overlap FTCR exceeds the transition period FTCR, then further clawback is required, and this is done under s24 TIOPA 2010 by assessing an amount of additional profit that represents the amount of excess credit in the next period (2024-25). 

Example – Calculating tax on overlap profits with FTCR

A trader commences trade on 1 October 2021 with accounts each year to 30 September. The trader’s profits and foreign tax paid are as follows:

 

Year ending	Profits	Foreign tax paid (15%)
30 September 2022	£10,000	£1,500
30 September 2023	£12,000	£1,800
30 September 2024	£15,000	£2,250
30 September 2025	£18,000	£2,700

 

The trader’s basis periods, taxable profits and FTCR [BM(BA&I5] [BM(BA&I6] for the tax years 2021/22 to 2024/25 are as follows:

 

Tax year	Basis period (tax year for 2024/25 onwards)	Taxable profit	FTCR
2021/22	1 October 2021 – 5 April 2022	£5,000 (£10,000 x 6/12)	£750 (£1,500 x 6/12)
2022/23	1 October 2021 – 30 September 2022	£10,000	£1,500
2023/24	1 October 2022 – 5 April 2024	£12,500 (see below)	£1,875 (see below)
2024/25	6 April 2024 – 5 April 2025	£16,500 (£15,000 x 6/12 + £18,000 x 6/12)	£2,475 (£2,250 x 6/12 + £2,700 x 6/12)

The taxable profit and FTCR for 2021/22 are 6/12ths of the profits and foreign tax of the year ended 30 September 2022. These are also the amounts of overlap profit and FTCR relating to the overlap period 1 October 2021 to 5 April 2022.

The taxable profits and FTCR for 2023/24 are found as follows:

·       First, calculate the profit and foreign tax for the transition part which is 1 October 2023 to 5 April 2024. This is 6/12ths of these amounts for the year ended 30 September 2024: £7,500 and £1,125

·       Next, deduct the overlap profit and associated FTCR (£5,000 and £750), giving £2,500 profit and £375 FTCR

·       Spread the results over up to 5 tax years. Assuming the minimum 20% is treated as taxable in 2023/24, this gives £500 profit and £75 FTCR

·       Add these amounts to the amounts for the standard profit and related FTCR in 2023/24, which are the figures for the year ended 30 September 2023. This gives the final figures for 2023/24 of £12,500 profit and £1,875 FTCR

The taxable profits and FTCR for 2024/25 are 6/12ths of the profits and foreign tax of each of the years ended 30 September 2024 and 2025.

Any apportionment that is necessary should generally be made in proportion to the number of days in the relevant periods.

An alternative time-apportionment basis suggested by the taxpayer can be accepted provided that it is reasonable and is applied consistently. An example might be time-apportionment by reference to the number of weeks or months in the relevant periods.

In this example, apportionment was by reference to the number of months in the relevant periods.