A new Government proposal, which will impact the tax position of unincorporated businesses, trusts and partnerships unless their accounting period is already aligned with the tax year end, has been delayed by a year. The proposal aligns with the Government’s plans for Making Tax Digital (MTD) for income tax, which has also been delayed by a year until April 2024.

The Government published a consultation and draft legislation in late July 2021 proposing “a simplification of the income tax system to support small businesses, helping them spend less time filing their taxes and making the rules fairer, more logical and easier to understand”.

This reform was originally due to come into effect in the 2023/24 tax year, but the Government has now announced that reform will not happen before April 2024, with the transition not before 2023/24.

Once implemented, the reform effectively means that all businesses (including sole traders, trading partnerships and trading LLPs) will be taxed on profits arising in the tax year (tax year basis) by 2024/25 rather than under the current system where profits are taxed on the business’s normal accounting year (current year basis).  This will remove the issue of overlap profits and overlap relief, which the Government claims leads to mistakes being made in tax returns. 2023/24 will be a transitional year allowing the move from current year basis to tax year basis, as explained below.

Current rules

Currently, unincorporated businesses, such as sole traders and partnerships, including LLPs, are taxed on the profit or loss for the 12 months ending with the accounting date which falls in the tax year, which is known as the ‘current year basis’.

For example a business with the accounting year end 30 April 2021, would be taxed on this income in the 2021/22 tax year.

Specific rules determine the basis period during the early years of trading.

Where the accounting year end date is not 5 April / 31 March, for the first three years of trade, the rules can create overlapping basis periods, which charge tax on profits twice and generate ‘overlap relief’. Relief for these double taxed profits is given when the business ceases, changes its accounting date or when the partner leaves the partnership / LLP.

Proposed changes

Regardless of a business’s accounting year end, from 2024/25, profits will be taxed on a tax year basis. Taking the example of a business with an accounting year end of 30 April, profits would be assessed as follows:

Where profits of the transitional element exceed overlap profits, the Government is proposing to allow taxpayers to spread those profits over a period of five years.

The effect of the rules will mean that a business's profit or loss is the profit or loss arising in the tax year itself, regardless of its accounting date. This may lead new businesses to adopt a 31 March / 5 April year end date and existing businesses to change theirs to a tax year end also. Where businesses continue to use a non-tax year end accounting date, profits will need to be apportioned and reported provisionally on tax returns if final figures are not known before the filing date. This is likely to result in more administration time for businesses and their advisers, particularly for those businesses which have accounting dates later in a tax year.

By way of example, if a business reports profits to 30 November each year, for tax year 2024/25 the 2024/25 return will need to report pro-rated profits for the 8 month period from 1/4/24 – 30/11/24 (from the accounts for the year to 30 November 2024) plus pro-rated profits for the 4 month period from 1/12/24 - 31/3/25 (from the accounts for the year to 30 November 2025). For the accounting date of 30 November 2025, this would mean completing accounts and tax computations within a very short period to allow the 2024/25 tax return to be lodged by 31 January 2026, or using estimated figures which would need to be amended at a later date, resulting in late payment interest and penalties being charged where profits are underestimated.

Issues to be aware of

There are a significant number of tax, accounting and management issues to be aware of and plan for around these changes including:

• Considering whether to change your accounting date to 31 March to avoid apportioning profits of different accounting years on tax returns
• Managing cash flows for tax particularly in the transitional period
• Ensuring your records are up to date as far as overlap relief is concerned
• Consideration of spreading transitional element profits to manage amongst other things, cliff edge tax rates, High Income Child Benefit Charges, loss of personal allowances and pensions annual allowance entitlement
• Being aware of risk of introducing provisional figures in tax returns (risk of late payment interest etc and extending HMRC enquiry window) 

Get in touch

This reform represents big changes for businesses, and thorough planning will be required. For more information or to discuss your requirements, please get in touch with me or your usual Johnston Carmichael contact.