Tax Legislation Day is basis for surprises ahead

It is proposed that from 2024 the basis on which the profits of sole traders and partnerships are computed for tax purposes is set to change, according to draft measures to be included in the next Finance Bill.

UPDATED 23 September 2021: Initially the year was set at 2023, but on 23 September 2021 it was changed to 2024. The dates and examples given below all now reflect this one year delay.

The measures were first published for consultation alongside other proposals as part of the government's so-called "Legislation Day".

The full list of tax measures can be found on the Finance Bill 2021/22 page.

A key surprise is the proposal that sole traders and partnerships will be taxed by reference to profits earned in a tax year, rather than taxed by reference to the profits of an accounting period where that period does not coincide with the tax year ended 5 April.

For example, a business draws up accounts to 30 June every year.

Currently, income tax for 2024/25 would be based on the profits in the business’s accounts for the year ended 30 June 2024.

The proposed reform would mean income tax for 2024/25 would be based on: 3/12 of y/e 30 June 2024, plus 9/12 of y/e June 2025. So there is an acceleration in profits being assessed and taxed.

For businesses with a year end of 5 April or 31 March, and those that are in the early years of trade, there will be no impact.

However, for other businesses that have a different year end, there will be an impact and costs.

Setting tax year 2024/25 as the year of change (with year 2023/24 as a transitional year) is very ambitious, even with a one year delay, and it is not clear why the government wishes to move so quickly.

The speed of change may have more to do with HMRC convenience and with its Making Tax Digital Income Tax Self-Assessment (MTD ITSA) project than of any altruistic desire to make the tax system simpler for the self-employed.  MTD ITSA is meant to become mandatory from April 2026 (delayed from April 2023).

Indeed, it could be seen as a further step towards tax reporting and payment being based on real-time information, more like an employee on PAYE.

Even so, if they are to proceed there could be further delays in such proposals being implemented, as we have seen with previous tax measures. Delays may reduce the chance of unforeseen consequences from a rushed consultation process.

The basis of winners and losers?

Who stands to gain from the change, besides HMRC, and who stands to lose out?

If the transitional year is 2023/24 (with 2022/23 being the last year under the current system), some businesses’ may be assessed on more than 12 months’ profits, with others becoming entitled to accelerate the use of any carried forward relief from earlier years.

So for businesses with growing profits the change to a tax year basis will mean a significant extra tax bill in the transitional year as the catch up with profits takes place. This is clearly shown where a 30 April year end is in place and those extra profits are taxed in the transition year, with no material amount of overlap relief available.

However, the measure does offer transitional provisions to spread the transition-period profits over five tax years, starting with 2023/24, with the option to accelerate. This does, however, carry the risk of tax and NIC rate rising during this period and also means businesses will have to manage their cashflows more closely to meet those extra tax payments in the five year period.

Also keep in mind that any additional profits brought into charge in the transitional period will be taxable at a taxpayer's marginal rate, even with the five-year spread option.

Additionally, it is not yet clear what happens where a partner leaves a partnership during the transitional period and the partnership has opted to use the five-year spread option.

Once fully implemented, the measures accelerate the taxation of profits from the current system, so a business with rising profits will be taxed sooner on those rising profits. However, where profits are falling, relief would be available much sooner. 

This measure would clearly affect cash flow, particularly where a business has significant debtors it is having to chase to be able to pay its tax bill and other costs.

In light of the proposals, a business may wish to change its year end to 31 March or 5 April, but there could be sound commercial reasons for not doing so, e.g. levels of stock in a seasonal business.

Indeed, businesses will still be free to choose their own accounting period under the new regime but the date would no longer have any impact for tax purposes. 

A problem of timing?

One problem area identified with the above is the impact on timetables for drawing up accounts.

Where, for example, a business has a 31 December year end, it would normally have its accounts prepared for the year ended 31 December 2024 for the tax year 2024/25 (i.e. the year end falls within the 2024/25 tax year to 5 April 2025).

So, currently that would require the y/e 31 Dec 2024 accounts figures to be submitted on the 2024/25 tax return by 31 January 2026, meaning there are 13 months to prepare the accounts (1 Jan 2025 to 31 Jan 2026).

However, if the above proposals are implemented as they are currently drafted that would mean the 2024/25 return would be based on: 9/12 of y/e 31 Dec 2024, plus 3/12 of y/e 31 Dec 2025.

Which would mean the figures will be required within one month of the end of y/e 31 Dec 2025 to meet the 31 Jan 2026 submission deadline, which would be a challenge - if not simply impossible.

One way around this would be to submit the return with estimated figures, which are later amended to the actual ones, although this is hardly tax simplification.

All the information relating to the proposal can be found on the Income Tax: Basis Period Reform page.

The consultation closed on 31 August 2021.

As stated above, the government has put back the proposals by one year.

In its response to the consultation, (before the one year delay was announced), the Institute of Chartered Accountants in England & Wales (ICAEW) said:

"ICAEW’s view is that the government should not introduce basis period reform on its current timetable. “This pace of change is unnecessary and counterproductive… implementation would be more successful if more time was taken for agents, taxpayers and HMRC to adapt to the changes.”

Instead, it recommended that HMRC takes a more holistic approach to tax system reforms, including considering the Office for Tax Simplification’s report on potentially moving the tax year away from the 5 April end date to either 31 March or 31 December.

Other tax proposals

Alongside the above surprise, other measures in the Legislation Day proposals include further restrictions on promotors of tax avoidance schemes, largely technical changes to hybrid and other mismatches, capital allowances for structures and buildings, and pension schemes.

Of interest is a proposed increase in the normal minimum pension age from 55 to 57 in April 2028.

There will also be a new requirement for large businesses to notify HMRC where they have adopted an uncertain tax treatment. This will apply to returns due to be filed on or after 1 April 2022. The requirement is triggered when:

• the business is taking a different tax interpretation HMRC’s known position; or
• a provision has been included in the accounts to reflect extra tax that may be payable because of an uncertainty over a legal interpretation; or
• there is a substantial possibility that the courts would decide that the treatment adopted by the business is incorrect.

The tax treatment of asset holding companies is also subject to proposed changes, designed to enhance the UK’s attractiveness as a location for these companies. This would have effect for corporation tax, stamp duty and stamp duty reserve tax from 1 April 2022 and for income tax and capital gains tax purposes from 6 April 2022.

HMRC has also published responses to various consultations.

What happens next?

Once all the consultations have ended in September, there will be a Finance Bill in the Autumn to accompany the Autumn Budget and a Spending Review.

See HMRC's Summary of Responses published November 2021.

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