Change of basis period – could be a significant change for the self-employed and partnerships

Draft legislation, announced on 21 July, signalled the government’s intention to move the basis on which the tax on trading profits of sole traders, partnerships and other unincorporated businesses are calculated.

The move, which would see trading profits being taxed in the tax year that they arise, rather than the accounting period ending in that tax year, will affect those not already aligned to the end of the tax year. Currently if your year end is 30 April 2021 then that is taxed in 2021/22, so that 11 months of the profit is taxed a year later than is the case for a year ended 31 March 2021. Therefore, businesses with a year end of 31 March / 5 April – will be largely unaffected.

So, who will be affected and why?

If you have a year-end date other than the end of March, there will be added complexity to your tax calculations as you will have to apportion profits to different tax years, depending on how many months fall into each.

In addition, for those businesses with year ends towards the end of the tax year – say 31 December, then actual profits may not be known, so estimated profits will be required, and then revised in due course.

Perhaps most significantly, this move will accelerate profits being assessed and taxed, with many businesses also being assessed on more than the 12 months profit in the transition year, adding further pressure on cash flow. If your business has growing profits, unless there is significant overlap relief available, there will be a significant uplift in tax bills in the next 12-18 months.

Currently there is a cashflow advantage to those businesses with year ends early in the tax year. At some point in their history, those businesses will have paid tax on profits twice and the amount of such double taxed profits is called overlap relief. Where profits are rising over time then this overlap relief will be modest compared to the extra profits now being taxed – hence there will be a big catch up for many businesses in the tax payable on 31 January 2024.

The change has been talked about for a while (including in my blog here) although the original timeline seemed incredibly fast with the proposed tax year basis set to apply from 2023/24 with 2022/23 being the transition year. However, on 23 September 2021, the Government announced a delay to the change of tax year basis so it will not come into force until at least April 2024 with the transition year no earlier than 2023. This is reflected in the delay to the implementation of Making tax digital for income tax (MTD ITSA) from April 2023 to April 2024.

Where could this be headed?

With the added complexity of apportioning profits and the loss of the attractive delay in paying tax on profits, the government seems to be encouraging these businesses to have to put in place a system to deliver real time tax adjusted profits. This is all part of MTD and the digitalisation of tax. As we have written previously it is beneficial to the government to get tax revenue in earlier and improve the government’s cashflow without raising tax rates. So, the cash will be in the government’s bank account rather than yours.

With a number of our clients clearly affected by this change, we will be looking closely at the proposed legislation as it develops and will be further analysing its impacts.