HMRC have published a consultation document proposing a change to the way in which the profits of unincorporated trading businesses (sole traders and partnerships) are allocated to tax years (known as a ‘basis period’). Whilst these changes are being billed as a simplification measure, they could have some quite unsavoury tax consequences for businesses which prepare accounts to a date other than 31 March or 5 April each year.
In general terms, the basis period will be determined by the accounting period which ends in the tax year in question. So by way of an example, a sole trader who prepares her accounts for the year to 30 June 2021 would report those profits in her 2021/2022 tax return and they would be taxed accordingly.
The proposed change would see all unincorporated businesses taxed on their trading profits in line with the tax year, and this would take effect from the 2023/2024 tax year onwards. So in the case of our sole trader who prepares her accounts to June each year, the 2023/2024 tax year would include 3/12 of the profits for the period to 30 June 2023, and then 9/12 of the profits for the period to 30 June 2024. Whilst there may be good commercial reasons for retaining a June year end, our expectation is that most businesses would change their year end to 31 March or 5 April once the new rules have been implemented.
The main difficulty with these changes lies in the ‘transition year’ of 2022/2023. This will require a business to not only assess profits to its normal accounting date, but to also assess additional ‘transitional’ profits covering the period from the end of the accounting period to 5 April 2023. So for example, the partners in a partnership which prepares accounts to 30 April each year would not only be taxed on profits to 30 April 2022, but would also be taxed on ‘transitional’ profits covering the period from 1 May 2022 to 5 April 2023 (i.e. they would be assessed on 23 months’ worth of profit!). Whilst there may be some overlap relief available by reference to profits that were taxed twice when the business commenced, in many cases this relief will be significantly lower than the additional profit that is being subject to tax.
On a slightly more positive note, HMRC have indicated that they would allow the taxpayer to elect to spread the additional ‘transitional’ profit over a 5 year period in order to assist with cashflow, and this may in some cases allow for tax-planning measures to be put in place to reduce the impact of the changes.
The consultation period closed on 31 August 2021, and the timing of the proposed changes have been met with resistance, in particular by the leading accountancy and tax professional bodies, which have signed a joint letter to the government urging them to delay their introduction. We are hopeful to receive clarity in terms of timescale sooner rather than later so that we can advise our clients accordingly and help them navigate this change.
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