Following the confirmation that the reform to income basis periods would be delayed by a year, some welcome amendments to the proposals have now also been tabled in the draft Finance Bill published on 4 November 2021.
A recap
As a reminder, in conjunction with Making Tax Digital for income tax, the Government is proposing to tax profits in line with the tax year, rather than the current approach of taxing profits which arise in the accounting period ending within the relevant tax year. This change will take effect from April 2024, with a transitional period in the 2023/24 tax year.
The rules will impact sole traders and partnerships who do not prepare their accounts to 31 March or 5 April. The change may result in an acceleration of profits into an earlier tax period for those with accounting periods differing to the tax year. There will be provisions to allow for any overlap profits to be relieved in the transitional period, along with the possibility to spread any excess transitional profits over the following five tax years.
Proposed changes
A number of concerns were raised with the original proposals including the impact that accelerated profits could have on available allowances and other means tested benefits, including the personal allowance, pension annual allowances and the high income child benefit charge.
The latest draft legislation includes amendments to treat the transitional profit as a one-off taxable item, such that it is not included in the net income calculation for calculating an individual’s entitlement to such allowances and benefits. However, even with this welcome provision, some taxpayers could still find themselves tipped into a higher tax bracket as a result of the accelerated profits.
Another amendment is to cover where a loss is created or increased when relieving overlap profits. The latest provisions allow for this loss to be carried back up to three years against trading profits rather than one. If more beneficial, the taxpayer can still choose, instead, to offset against total income with a one-year carry back.
The updated legislation also appears to allow for a change of year end 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 first draft of the rules, this was not possible.
Finally, the Government has recognised that there will be administrative issues for those businesses with an accounting period end towards the end of the tax year (e.g. December year ends). Such businesses will have just one month to finalise their accounts and apportion profits accordingly. Options are still being explored to address this issue but currently being considered include:
- Allowing a provisional figure to be amended at the same time as filing the following year’s tax return
- Extending the filing deadline for certain taxpayers e.g. more complex partnerships or seasonal trades
- Amending any differences between provisional and actual figures in the following year's tax return
- Retaining current rules such that any estimated figures would need to be amended once known.