Following on from the Budget announcement last week in which the reform was widely publicised, yesterday saw a further announcement delaying the implementation by a tax year so we summarise what we know currently.
Firstly, who does this affect?
The proposed changes will affect self-employed individuals, partners in a partnership, trading trusts and estates and other unincorporated entities with trading income charged to income tax.
What are the current rules?
Currently the above mentioned businesses are able to choose any year-end they wish and prepare their accounts up to that same date each year. Then, when it comes to doing their tax return they will be taxed on the accounting year-end which falls within the tax year. For example, a year end of 30th June 2020 will be taxed in the 2020/21 tax year and a year end of 31 January 2021 will also be taxed in the 2020/21 tax year, as both year-ends fall within the period 6th April 2020 to 5th April 2021 i.e. the 2020/21 tax year.
When your business has a year-end that is not in line with the tax year (i.e. not 31st March/ 5th April) there are extra complexities and adjustments required in the first and last years which can create something called overlap profit.
What are the proposed changes?
HMRC are proposing to tax affected businesses on a ‘tax year basis’. This will mean a business’ profit (or loss) arising in a tax year will get taxed in the tax year itself, regardless of the business’ accounting date.
What are the main issues?
One of the first questions you’ll likely ask is how you go from getting taxed on your accounting year-end, to the tax year-end of 5th April instead. The answer is that HMRC are proposing that the 2023/24 tax year is treated as a transitional period where you would get taxed on your year-end as normal, plus the remaining months in the tax year.
The issue with this is you will likely be taxed on more than the normal 12 months during the transitional year of 2023/24. This not only could cause you to pay more tax, it could cause you to reach the next tax band and start paying higher rate tax, losing your personal allowance etc. It could also cause issues for any means-tested benefits being claimed.
There are also other issues around the practicalities of this, especially for business that may not be able to acquire all the information required to prepare figures to 5th April by the January filing deadline.
So, what’s new and what are HMRC going to do about this?
HMRC have released their response to feedback on the proposed changes. As a result the government has advised they will treat any excess profits arising during the transitional year as a one-off separate item of taxable income, rather than including it as part of the business’ regular trading income. Doing so will help minimise the impacts on allowances and means-tested benefits.
HMRC have also confirmed there will be an extension to the carry-back of loss relief, from one to three years, which could arise if you have excess overlap profits to deduct. However, this is unlikely to apply for many business unless your profits in 2023/24 are far less than in your first year or two of trading.
It has also previously been announced that any excess tax on profits arising from the transitional period can be spread over a period of up to 5 years to help minimise the impact on cash flow.
There are also several options still being considered to help support those business who may be unable to prepare figures to 5th April by the filing deadline and will have to use provisional figures, further guidance on this will be released in due course.
Why is this being done?
Although it may not seem like it from the above the intention is to have a simplification of the current rules, whereby each business can be taxed on different periods in a tax year and there are often complicated calculations during a business’ first and last years of trade.
This will also help with the government’s plans to have all businesses reporting under Making Tax Digital (MTD), by aligning accounting periods with the tax year.
Finally, what should I do next?
Please do not hesitate to give your regular contact at Randall & Payne a call to discuss any queries or concerns on 01242 776000 or email Tax@randall-payne.co.uk. We also recommend keeping an eye on our website and social media pages for any further updates.