Recently, HM Revenue & Customs (HMRC) published a consultation report on basis period reform. This document proposes that from April 2023 businesses will report profits or losses accrued to 5 April, no matter their accounting year end. This change will mainly affect sole traders and partnerships with trading income that do not have 31 March or 5 April year ends. This proposal will remove complex basis period rules and prevent the creation of overlap relief. Affected businesses will not only have this to consider but also the impact of quarterly reporting as introduced by Making Tax Digital.
What does the change mean?
The aim of the proposed consultation is to simplify the rules by aligning every self-assessed trader to be taxed for the same time period (i.e. 6 April – 5 April) no matter the accounting year end date. This means that for those businesses who do not have a 5 April year end, there will be an annual requirement to apportion profits and provide estimated figures (with finalised amendments being made at a later date). This process may cause both a cashflow and an accounting headache for those impacted. Therefore, HMRC are suggesting changing the businesses year end may be the more favourable option in the long term.
Why are HMRC making these changes?
This change is being brought about as the current system is considered to be complicated and potentially unfair to some taxpayers. Those taxpayers with an earlier year end date, (i.e. 30 April) can defer tax by almost a full year in comparison to those with a later end date (i.e. 31 March or 5 April). The proposed changes aim to allow for fairer outcomes between businesses and for tax paid closer to the time of taxable profit being earned.
What will these changes look like?
For example, a business with a year-end 31 October will currently for the tax year 2021/22 be assessed by reference to the profits (and adjusted for tax purposes) of the year ending 31 October 2021 i.e. income tax and NIC payable by 31 January 2023. From the 2022/23 tax year, HMRC is proposing to charge tax from 1 November 2021 to 5 April 2023 and will be known as the ‘transition period’ i.e. by 31 January 2024, income tax and NIC will be payable on an additional 5 months of trading profits.
This may create cash flow issues for some businesses and in this case HMRC have provided solutions to relieve affected taxpayers of this initial burden.
Firstly, a transition period is proposed with two elements determining the basis of taxation for the 2022/23 tax year. This means that based on the above example, the basis period for a business with a 31 October year end would be determined by adding together the following two periods:
Overlap profits from earlier years of trade must be deducted from the second component which will provide some initial tax relief. This overlap in profit will vary depending on a business accounting year end, how long a business has been trading and is normally provided upon business cessation e.g. if the first period of trading was loss making, overlap relief may not be relevant.
Secondly, HMRC have suggested that any increase in taxable income that is brought about by the change of basis periods can be spread over five tax years 2022/23 to 2026/27. This will allow sole traders to determine the most optimal time to pay their additional tax due.
From 2023/24, all sole traders and partnerships would be operating on a tax year basis i.e. 6 April to 5 April.
How can we help?
In summary, these proposed changes will bring forward the timing of tax payments and, for those affected by this change, the new system could potentially cause a variety of short-term problems e.g. cash flow may be heavily impacted given the accelerated tax payment schedule. Forward planning and forecasting will, therefore, be essential especially for professional partnerships and/or seasonal businesses which have strong trading profits around the beginning of the calendar year.
If you believe you may be affected by these changes and would like to discuss the impact for you, please get in touch.
This blog was written by Personal Tax Senior Manager Michael Jamieson and Personal Tax Assistant Amy McLaughlin.
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