The Government is simplifying the rules under which profits are allocated to tax years using basis periods. While the reform will bring simplification, it will also bring with it complications for those businesses with a non-tax year accounting end.
The aim of the new rules is to simplify the system of allocating trading income to tax years. The self-employed and partners in trading partnerships will be taxed on profits arising in a tax year, aligning the way self-employed profits are taxed with other forms of income, such as property and investment income. You can read more detail on these changes in our previous article here.
Are the new rules good news?
On the surface, the basis period changes appear to be good news, with the removal of the complicated rules around commencement, cessation and changes of accounting date. Instead, tax will be payable on profits arising in the tax year.
As you dig a little deeper into these changes, however, they throw up a host of other potential issues for unincorporated businesses, where the accounting year end is something other than 31 March (5 April).
Transition year issues
The most obvious is the acceleration of profits taxable in the transition year, to align the basis period with the tax year. While some relief will be available in the form of an automatic deduction for overlap profits, the chances are that these will be lower than the accelerated profits. This is likely to have a cashflow impact, as the income tax and national insurance due on these ‘transition profits’ will be payable one year earlier than under the current basis period rules.
To help ease the burden, the Government has provided for an automatic 5-year spreading of the additional charge. The individual trader will also have the option to bring an additional amount of transition profits into charge in any of those 5 years. This could provide planning opportunities so that transition profits are taxed when the taxpayer’s personal marginal rate of tax is at its lowest.
The flexibility to accelerate transition profits will invariably lead to an additional administrative burden for some businesses, particularly partnerships that retain a tax reserve on profits. As transition profits will be taxed as a separate source of trading income, a separate tax reserve will be needed, along with an ongoing record of transition profits for each partner. To help manage this, partnerships may consider adopting a policy regarding the spreading of profit for all its partners, while providing for exceptions such as an impending retirement.
Exploring provisional figures
The new rules will also mean that provisional figures may be required when filing partnership and individual partner tax returns by 31 January. This is because businesses may not have completed both sets of accounts and tax computations in time to correctly apportion the profits on a ‘tax year’ basis. An amended tax return will then be required at a later date, which will also extend the enquiry window into the amended figures. The current rule for tax return amendments is that taxpayers should amend a provisional figure as soon as the final figure is available and to pay any additional tax, and interest, within 30 days of the amendment.
HMRC recognises that this will cause an additional administration burden for businesses and tax advisers, and it has recently released a technical paper on how to address the impact of reporting provisional figures. HMRC’s proposed options to ease the administration burden are:
- Allow taxpayers to amend a provisional figure included on a tax return at the same time as they file a tax return for the following tax year. This would prevent taxpayers having to make an out-of-cycle filing.
- Allow an extension to the filing deadline for specific groups of taxpayers, such as complex partnerships, which could be based upon the firm’s accounting date, similar to corporate tax filings. Further details have not been confirmed.
- Allow taxpayers to include any differences between provisional and actual figures for the previous tax year as an adjustment to profit in the following tax return.
HMRC is also looking at partnership-specific easements for provisional figures to try and ease the administration burden for complex and large partnerships. One suggestion is that instead of amending each partner’s tax return, there could be partnership-level reporting to notify HMRC of the amendments. These may then be automatically fed through to the individual partners’ tax returns.
We can work alongside businesses and individuals to understand the impact of the proposals and any actions that could be considered prior to the introduction of the new rules.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
Tax legislation is that prevailing at the time, is subject to change without notice and depends on individual circumstances. Clients should always seek appropriate tax advice before making decisions. HMRC Tax Year 2022/23.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.