Whilst the proposals for Making Tax Digital for income Tax have now been delayed by a year such that for sole traders and landlords with income over the threshold the legislation will be mandated from 6 April 2024 (and for general partnerships from April 2025), it was announced in the recent Budget that the proposals announced in July 2021 regarding basis period reform will also proceed in 2024/25 with the transitional year in 2023/24.
The purpose of the reform is in effect to ensure that the self employed and trading partnerships are 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.
The proposal will mainly impact those businesses that do not draw up annual accounts to 31 March or 5 April, or those in the early years of trade.
At present profit or losses disclosed on tax returns by the self employed are generally based on the business’ set of accounts ending in the tax year. This is known as the current year basis. There are more complex rules in the earlier years of trade and where the accounting date is not 5 April or 31 March, self employed individuals are taxed on some profits twice, generating overlap profits. These overlap profits are carried forward and relief given in the final tax year when the business ceases or upon change of accounting date. This ensures profits generated during the duration of that trade are only taxed once.
Under the current rules it is possible to defer the payment of income tax on profits by up to a year by choosing an accounting date early in the tax year such as 30 April, whereas those businesses that have an accounting date that aligns with the tax year will pay tax on profits much earlier.
Legislation will be introduced in the Finance Bill 2021/22 to replace the current year basis with the tax year basis with effect from 2024/25 with transition in 2023/24. Whilst there is no need for a business to actually change its accounts year, businesses with an accounting date other than the end of the tax year will need, for tax purposes, to apportion profits and losses from the different accounting periods to align with the tax year. This may of course require the use of provisional profit figures for a later accounting period if they are not prepared before the required filing deadline.
2023/24 Transitional Year
In the transitional year all businesses will have their basis periods moved to the end of the tax year and any overlap relief given. For businesses with an accounting date other than the tax year end this will potentially accelerate profits into an earlier tax year increasing tax liabilities for the transitional year. This may impact on cash flow particularly around January 2025 when the balancing payment is due.
For businesses with higher profits in 2023/24 due to the change in the rules, the Government is legislating to automatically spread the additional profits over a period of five years. The Government is also legislating to allow a business to elect out of spreading to accelerate the tax charge if they wish.
If however a trade ceases before the whole of the transitional period of profits have been charged to tax, the balance will be immediately brought into charge in the year of cessation.
- Businesses may need to finalise accounts and tax computations earlier.
- There may be a cash flow impact as a result of the extra tax payable in the transitional year and costs of preparing and dealing with the new rules.
- For retiring partners the proposals could alter the optimal date for retirement.
- Whilst there is no statutory requirement for businesses to adopt an accounting date in line with the tax year, many businesses may choose to adopt a 31 March year end in the transitional year 2023/24 in order to simplify their affairs and spread the additional profits over the proposed five year option.