News

In July 2021, the Government issued a consultation and draft legislation for a proposed change in the way profits are taxed for those sole practitioners, partnerships and LLPs that do not prepare their accounts to 31 March or 5 April. This is part of a bigger project moving towards Making Tax Digital for income tax.

HMRC has proposed that all self-employed individuals and partners will in future be taxed on a tax year basis, rather than an accounting year basis, i.e. individuals will pay tax on profits arising in each tax year, regardless of the firm’s accounting date. 

The consultation originally recommended implementation of these changes from April 2023, with a transitional period in the 2022/23 tax year.

Announcements in October Budget

Since the consultation, there have been some welcome amendments to the original draft legislation:

1. The change will now take place from April 2024, with a transitional period in 2023/24 – a whole year later than originally planned, which gives everyone more time to prepare.
2. An adjustment to the way that income is calculated for the purposes of restricting personal allowances, pension annual allowances and higher income tax benefit charge, so that the transitional period will not impact on these specific allowances.
3. The updated legislation also appears to allow for a change of accounting date to 31 March or 5 April 2024 in the transitional year and still allow spreading of
   transitional profits up to that date over five years. In the draft legislation this was not possible.
4. The Government has recognised that there will be administration issues for firms with an accounting date close to the end of the tax retun filing date (e.g. December year-ends), as those firms will have just one month to finalise their accounts and apportion profits accordingly before they are included on tax returns. Whilst not yet finalised, options that are being currently explored to address this issue include:
   1. Reporting provisional figures on the tax return, which can be amended at the same time as filing the following year’s tax return.
   2. Extending the filing deadline for certain taxpayers e.g. the more complex partnerships, etc. 
   3. Amending any differences between provisional and actual figures within the following year’s tax return.
   4. Retaining the current rules, so that estimated figures can be amended once the actual figures are known.

Pulling this all together, and by way of an example, the table below summarises the impact of changes over the next five years on a firm with a 30 September accounting date.

Action required now

Whilst the 12 month delay in the introduction of these new rules will be welcomed, all it is doing is delaying the inevitable, and firms need to start focusing on what needs to be done now, so they are ready to deal with the change. This includes:

1. For most firms, the changes will not involve paying more tax – rather it is an acceleration of tax payments, and therefore it is a cashflow management challenge. Managing lock-up is key to allowing sufficient cash to be generated over the period of the transition. Good lock-up management starts from the moment you take on a client, and reminding all staff of the need to communicate with clients, bill regularly, etc. is all going to help.
2. The decision of whether to spread the transitional profits over five years lies with the partner, not the firm. A partner may, for personal reasons, prefer to accelerate the transitional profits, but if the firm usually pays the tax then there could be a potential conflict between what works for one party but not the other. Preparing projections of what the transitional period could look like for the firm and individuals, even at this stage, with various scenarios, is important, as it should allow for all of those issues to come to the surface.
3. For owners that are looking to retire between now and 2027/28, timing of retirement is key, and the impact of the spreading needs to be considered as part of the plan, particularly in terms of timing of pension contributions, etc. Taking advice early on and, where possible, being open with fellow partners about retirement plans, will help smooth over the cashflow impact for all parties.
4. Although 2023/24 seems a long way off, it will come around very quickly. Scenario planning needs to be looked at in terms of growth, timing of investments, etc, over the next three to four years, whilst dealing with the transitional period, which will allow a firm to look at ways of managing the overall cashflow impact.