Important information for sole traders and partnerships.
HMRC is currently consulting on a proposal to simplify the taxation of trading profits as part of its measures to simplify the tax system.
The proposal for basis period reform will affect sole traders or partnerships which do not draw up annual accounts to 31st March or 5th April, including those that are newly trading.
The proposal changes the way trading income is allocated to tax years from a ‘current year basis period based on your accounting year end’ to an ‘actual tax year basis based on the year ending 31st March’ with effect from 2023 to 2024.
Unincorporated businesses will be taxed on the profits arising in each tax year, rather than the profits of an accounting period ending in that tax year which is the current general rule for ongoing businesses. The proposals would also mean the end of overlap relief.
Businesses, such as seasonal businesses, who do not draw up annual accounts to 31st March or 5th April, and particularly those who do so later in the year may find this change problematic.
The allocation of profits in an accounting period to tax years is complex. For example, a business with accounts made up to 30 June would need to change the basis of its taxation to include 3/12 of the results from those accounts in the particular tax year, added to the 9/12 from the next accounting period, to now make up the full year to 31st March.
It may lead to the need for estimations as, for example, a business with a December year end would not be able to finalise its accounts in time to allocate profits to the previous tax year.
For some businesses, the change to a tax-year basis would mean a significant additional tax bill in the transitional year (2022-23) on profits that are taxed to “catch up” on the proportion of the basis period not taxed in the previous tax year.
Businesses may wish to consider changing their year-end date to 31st March or 5th April but before you do you will need to consider:
- Whether it is advantageous to change your financial year end now to accelerate losses or poor profitability for the period ending 31st March 2021, due to COVID restrictions.
- Does the change in base period reduce or increase your taxable profits?
- When is the best time to change your financial year end to 31st March 2021, 2022 or 2023?
- The impact of Making Tax Digital (MTD) changes which come into force on 1st April 2023 which require quarterly income tax returns, may also need to be taken in to account. (Changing your financial year end to 31st March 2023 defers MTD quarterly income tax returns for another year to 2024.)
Professional advice from your accountant is vital so that they can perform the necessary calculations and advise you on the best course of action. Each case needs to be considered on its own merits in order to assess the taxable profits created by changing your financial year end and therefore your base periods for taxation, and assess whether this increases or reduces your overall tax liability.
NB: The ICAEW (Institute of Chartered Accountants in England and Wales) is calling for the Government to drop the proposal and argues such reforms would be likely to “… increase costs, complexity and uncertainty for those businesses affected.”
If you require more information, please contact Lamont Pridmore our Strategic Partner on 0800 2346978 or email firstname.lastname@example.org