HMRC has launched a consultation on the reform of income tax basis periods, proposing a big shake up for the taxation of sole traders and partners.
In conjunction with the introduction of Making Tax Digital (MTD) for income tax, HMRC is now looking to tax profits in line with the tax year, rather than the current approach of taxing profits based on the accounting period of the business.
This change will impact all individuals and partners that do not have a 31 March or 5 April accounting year end date. The new rules are due to come in from April 2023, at the same time as MTD for income tax, however, a transitional period will apply in the 2022/23 tax year.
Taking an example of a partnership which draws its accounts up to 31 December, should the proposals go ahead, the partners will have to report and pay tax on the following profits in 2022/23:
- Profit share for the period from 1 January 2022 to 31 December 2022 (as currently); plus
- Profit share for the period from 1 January 2023 to 5 April 2023; less
- Overlap relief brought forward.
In the 2023/24 tax year, the partners will then be taxed on:
- 9/12 of their profit share from the accounting year ended 31 December 2023; plus
- 3/12 of their profit share from the accounting year ended 31 December 2024.
This will clearly lead to an acceleration of tax liabilities and as such, the consultation does propose that there will be some spreading provisions. It is anticipated that any additional tax liability arising as a result of the transitional rules in 2022/23 (e.g. profit for the accelerated period to 5 April 2023 less any overlap profit) can be spread over five tax years, rather than all being taxed up front. Although this will be a welcome provision, it will still result in an accelerated tax liability and taxing individuals at their highest marginal rate each year.
Further to the above, the filing deadline for the 2022/23 tax return will be 31 January 2024. This would give just one month for the business to finalise accounts for the accounting period ending 31 December 2023 and allocate profits accordingly to the period to 5 April 2023. In such cases, estimates will instead be required, which could then mean having to go back and amend returns at a later date. Some other options have been suggested to deal with this issue in the consultation, but exact details are yet to be finalised.
This change will likely lead to a much needed boost to the tax coffers for HMRC but it could undoubtedly have a significant impact on cashflow for many taxpayers. It appears that HMRC’s hope is that many businesses will look to change their accounting date to 31 March for simplicity, however, the timing of this should be considered as it could also result in an accelerated tax liability but without the option to spread this over five years.
The consultation runs until 31 August and an update on the final proposals is expected in the Autumn. Although the reform is still at consultation stage, it appears that HMRC are keen to plough ahead with this change as, unusually, draft legislation has also been published alongside the consultation.
If you would like to discuss further how this could impact you and your business, please do get in touch with Nick Haines (contact details below) or your usual tax contact at Hazlewoods.