How income tax payable by unincorporated businesses, such as sole traders or partnerships, is calculated changed under new rules brought in by HMRC in April (2023). The tax body is worried that many businesses still seem to have not heeded its warnings about how it will impact them.
Put simply, some could pay much more in tax and be burdened with extra unnecessary admin too. The problem does not just affect practices, but locums too if they operate in a way that is caught by the new rules.
The change to what is known as the ‘basis period’ rules will make little or no difference to the many businesses that already have an April 5 or March 31 year end. As Emma Rawson, a technical officer at the Association of Taxation Technicians, points out: ‘For those with accounting years that do not align with the tax year, the impact will be significant.’
Unfortunately, she says: ‘Many businesses who could be hit by this change remain unaware of it. The resulting temporary increase in their tax bills, and ongoing additional admin burdens, could therefore come as a nasty shock.’
What changed
Currently, once established, sole traders and partnerships pay income tax on the profits of their accounting year ending in the tax year. For example, if a trader draws up accounts to December 31 each year, in the tax year 2022/23 it will be taxed on profits for the year ended December 31, 2022.
From April 2024, Rawson says this will all change, and they will instead pay tax on the profits they actually earn in any one tax year.
She notes: ‘Tax year 2023/24 is a “transitional year”, in which the tax system swaps over from the current basis to the new tax year basis. To achieve this, special rules apply to calculate taxable profits and tax. Effectively, those that have a year-end other than March 31 or April 5, will be taxed on their normal basis period plus an extra amount of profits to bring them up to the end of the tax year.’
So, a business with a December 31 year end will be taxed on their profits for the year ended December 31, 2023 plus their profits for the period from January 1, 2024 to April 5, 2024.
Rawson highlights that this will result in more than 12 months’ worth of profit being taxed in 2023/24. To help ease any additional tax arising as a result, she says: ‘Businesses can offset any “overlap profits” they may have from their early years of trading (when they may have been taxed twice due to how the old basis period rules work). They may also be able to spread any remaining “excess profits” over up to five years.’
The problem outlined
As noted above, the transitional year rules could see a temporary increase in the tax payable by businesses without a March 31 or April 5 year-end. However, for Rawson, that is not the end of the story as these businesses will also experience additional admin burdens.
In particular, she warns that once these changes come in, those that draw up accounts to something other than March 31 or April 5, will have extra work to do each time they complete their tax return: ‘To get to the profits for a tax year, they will need to combine amounts from two separate sets of accounts and depending on how late the accounting date falls, the second set of accounts may not be ready by the time they file their tax return.’
Where this is the case, she says: ‘They will have to estimate the amount of profits to take from the second set of accounts and include a “provisional figure” on the tax return. They will then need to amend the return to correct that provisional figure within one year of the original filing deadline, for example, by January 31, 2027 for a 2024/25 return.’
These extra steps are not a one-off but will recur every year when they prepare their tax return.
The path ahead
With the change set out, Rawson says the best way to avoid these ongoing burdens is to change the accounting date to March 31 or April 5.
Luckily, for the moment, Rawson says it is possible to change the accounting date by drawing up a set of accounts for a shorter, or longer, period than usual, ending with the new accounting date.
She says the best time to make this change may be during the transitional year 2023/24. This is because ‘special rules applying in that tax year may allow them to spread any excess profits they have to bring into account as a result over up to five years, something which isn’t available if they make the change in any other tax year.’
Beyond that, Rawson explains: ‘Another advantage of changing in 2023/24 is that the normal rule, which says a set of accounts can’t be longer than 18 months, is disapplied in that year. This means that they can draw up one long set of accounts to make the change.’
In Rawson’s view: ‘Changing an accounting date to March 31 or April 5 will undoubtedly make a trader’s life easier from a tax perspective.’
Before making any business changes it is necessary to weigh up what is best for the business overall alongside the tax-related issues.