The profits chargeable to tax for those with a year-end other than 31 March are changing. So if your practice accounts are prepared to a date other than 31 March then you will need to understand how these changes may affect you. James Gransby points the way.
*** James Gransby is head of medical practices at RSM.
I have a 31 March year end – do I need to read this article?
You will not be affected by the changes and so need not read this, although it will give a greater awareness of the impact the changes may have on your accountant when many of their clients will be switching to the same year end as yours.
What is changing?
Tax for sole traders and partnerships is moving to the ‘tax year basis’ of reporting meaning that businesses will be subject to tax on their profits arising in the tax year, regardless of their accounting period end.
Aren’t profits taxed this way already?
No, a different method currently applies.
Profits are currently taxed on what is known as the ‘current year basis’ which means your 12 months accounting year end falling within a tax year is used as the basis for reporting your taxable profits for that tax year.
There are specific rules around the first tax year that you are in partnership (called opening year rules) which create ‘overlap profits’ which will be relevant as part of these changes.
Can you give examples to help illustrate?
Let’s use 30 April as an example, it also happens to be the year end for which these changes have the most profound effect.
Using last tax year as an example: The 2022-23 tax year ran from 6 April 2022 to 5 April 2023. Because the year-end date of 30 April 2022 fell in this period then it is the profits from that twelve-month period which were taxed in the 2022-23 tax year.
The deadline for completing and submitting the tax return for the 2022-23 tax year is 31 January 2024. The tax payment being made on 31 January 2024 is therefore any residual tax payable (or refund) on those profits which was not paid as part of the 31 January 2023 and 31 July 2023 payments on account, plus a half payment on account towards the 2023-24 tax liability.
Contrast that to a 31 March year end where the relevant year end for reporting purposes was 31 March 2023 and you can see that the partnership with the 30 April year end is 11 months behind in terms of reporting its taxable profits.
How do the new rules work in this scenario?
Under the new ‘tax year basis’, if staying with a 30 April year end then the reported profits would be time apportioned, taking one month from one set of accounts and eleven months from the next.
For example, for the 2024-25 tax year when the rules are fully embedded, if keeping a 30 April year end the 2024-25 tax year would consist of 1/12th of the year ended 30 April 2024 accounts plus 11/12ths of the year ended 30 April 2025 accounts.
Consider this for a 31 December year end and you would need to complete the accounts within one month to know the accurate figure to include on your tax return to be submitted by 31 January following the end of the tax year. This is not sufficient time to perform this work.
It is possible to submit an estimated tax return, to be updated later when the actual profits are known. But because these profits will also be used for preparing Type 1 Superannuation Certificates then this would also mean updating these forms and sending amended figures to PCSE which could cause administrative headaches.
Are most GP surgeries likely to prepare accounts to 31 March in that case then?
Most probably, yes.
The extra profits will be crystallised under the change in rules anyway, despite whether you change the year end or not.
If changing the year end to 31 March as part of the 2023-24 transitional tax year then you can take advantage of ‘transitional relief’ which spreads any additional tax burden for up to five years.
Accounts cannot exceed 18 months in total for tax purposes and so for 30 September year ends onwards there is the ability to prepare a long set of accounts to 31 March 2024.
This is particularly useful for 31 December year ends although many September year ends may wish to prepare a 12-month set to 30 September 2023 and a short six month set to 31 March 2024.
When do the new rules come into effect?
The new rules are fully embedded in the 2024-25 tax year with the 2023-24 tax year being a ‘transitional year’ when the new alignment takes place and the ‘transition profits’ are calculated.
What are ‘transitional profits’ and are they any different to just being taxed on extra profit?
This is the term given to the extra profit assessable to tax. So, in the 30 April example it will be the 11 months profits from 1 May 2023 to 31 March 2024 which now need to be assessed in the 2023-24 tax year.
They are not the same as normal profits in one important aspect. They do not form part of your profits used to see if your pensions annual allowance should be tapered.
This is a technical point but a very useful one in the case of those in the NHS Pension Scheme as it could have increased tax.
The default position on the transitional profits is that they will be spread equally over five tax years with the possibility to elect for them to be taxed sooner if you wish to. You will be able to deduct any brought forward ‘overlap profits’ which would have arisen when you first became partner or on a previous change of year end.
So overlap profits will benefit me, will I have these and how can I find out?
Absolutely they will help.
If your profits in the transitional year are similar to those that you earned in your first year of partnership then you could find that your overlap profits fully wipe out the extra profits being taxed now. If profits are lower now than in your first year then it could potentially lead to a tax advantage as your overlap profits may be greater than the transitional profits. This is more likely for newer partners, but also those who have dropped sessions since they first became a partner.
Your accountant will likely know your overlap profit figure which can also be found on your personal tax return in most cases.
As these may have been created over 20 years ago for some people then a record of them may have been lost but HMRC has put measures in place to be able to retrieve the figure if it is not readily known.
This extra transitional profit and five year spreading seems very relevant here. Won’t everyone just simply allow this to be spread over the five years by default in order to spread the cash flow effect?
No, not necessarily.
For example, if you know you will be paying tax in a higher band if you spread the profits then you may choose to accelerate it into an earlier tax year. If a future Budget increases the tax rate this would also have the same effect.
This can be illustrated with an example as to the importance of individualised calculations to check whether to spread or not:
Let’s take two partners who each have an additional £70,000 of transitional profits arising because of these changes. We know that spreading these over five years would give rise to an extra £14,000 of taxable profits to arise in each tax year.
Partner one earns £86,000 consistently each year and partner two earns £111,000 consistently prior to this adjustment being added.
There is an effective 60% tax rate payable between £100,000 and £125,140 which is very relevant here where the personal allowance is lost at a rate of £1 for every £2 earned over £100,000.
Partner one – They would benefit from spreading the extra profits over five years because the extra £14,000 would be taxed in the 40% tax band each year.
In fact this partner would save just over £6,500 of tax by using the default spreading option compared to paying it all in year one.
Partner two – If this partner was to use the five year spreading then each year the extra profits would fall within the effective 60% tax band.
This partner would therefore benefit from not spreading and would save over £8,000 by electing to tax all the extra profits immediately.
Prediction of future profits are never going to be an exact science but an educated assessment can often be made to ensure an appropriate option is chosen given the information available at the time. Tax bandings can also change over the period and so vigilance is required.
How does this interact with pensionable profits?
We are currently unsure exactly, but the logical move would be for superannuated profits to follow the tax treatment and so this is what is anticipated.
With this in mind, if pension is to be accessed within that five-year spreading timeframe then acceleration of the transitional profits may be necessary to ensure they are included in calculations for pension purposes.
Would I have had to pay tax on these profits at some point anyway?
Yes, you would have had to pay tax on these extra months’ of profits when you leave partnership and so, to put a positive spin on the changes, it allows you to take the extra profits and spread them over a longer period than would otherwise be the default.
But they may be being taxed in a higher tax band, particularly if you are planning to reduce sessional commitments in the run up to retirement which may have dropped you into a lower tax band for your final tax year.
What actions do I need to take now?
We can discuss the options with you and hopefully this article gives useful background knowledge.
But there is no substitute for personalised advice and so this is something that will be very much front of mind when discussing your tax affairs.
This article first appeared in the Autumn 2023 issue of AISMA Doctor Newsline.
Contact us on 01242 776000 or email firstname.lastname@example.org if you would like to speak to one of our experts.