These changes impact sole traders and partnerships and involve moving from the ‘current year’ basis to a ‘tax year’ basis, meaning that business profits will be calculated for the tax year rather than for the period of account (i.e. accounting year).
The move to this new tax year basis will involve a transitional (catch-up) year for many sole traders and partnerships that do not use 5 April or 31 March as their accounting year end date. This will advance tax liabilities for many, and good planning will be needed. The change comes into place in 2024/25, with 2023/24 as a transitional year.
These changes are being implemented as part of the governments Making Tax Digital agenda (due to be phased in from April 2026) and the possibility of accelerated self-assessment payments in the future (subject to government proposals, and speculation at present).
New tax year basis
Moving to the tax year basis period will require businesses to report for the 6 April – 5 April tax year for trading purposes, regardless of their actual accounting period. Businesses with non-tax year accounting periods would be required to apportion profits or losses across accounting periods to adjust their results to the tax year basis (i.e. on a monthly basis). For any periods where accounts are not yet finalised, but tax returns are required to be filed, this apportionment will require estimated figures and then a subsequent amendment which may increase the administrative burden on the taxpayer.
A business makes up its accounts to 30 June annually.
On the current year basis (current rules), its basis period for the 2024/25 tax year would be:
- Profits of the year to 30 June 2024 (i.e. the accounting period ending within the tax year).
Under the tax year basis (new rules), the business will report for the 12 months to 31 March 2025, so the apportionment would be:
- 3/12 of its profits/losses for the period of account to 30 June 2024, PLUS
- 9/12 of its profits/losses for the period of account to 30 June 2025.
If the accounts to 30 June 2025 are not yet finalised by the time the 2024/25 tax return is due, estimated figures will be required to be used and subsequent amendments made.
The additional administrative burden of producing estimates is acknowledged, and HMRC is consulting on how best to help taxpayers with the transition.
The legislation will treat periods of account drawn up to 31 March as equivalent to the end of the normal tax year (5 April), so no further apportionment would be required.
Phasing out overlap profits
Overlap profits may have arisen for some taxpayers that have accounting periods that do not currently align with the tax year. These overlap profits occur in the first period of starting a sole trade business or becoming a partner in a partnership or possibly on a change of accounting period. These changes being introduced will eliminate overlap profits due to all profits being taxed on a tax year basis. For some taxpayers, it could have a big impact on their tax liabilities when the changes are put in place in 2023/24, and good planning will be required.
Transitional year (2023/24)
The tax year of transition will be 6 April 2023 – 5 April 2024. In 2023/24, continuing businesses will be taxable on their profits on the current year basis (ie for the 12 months to their accounting date in 2023/24, plus the period up to the end of the tax year (ie 31 March for simple apportionment). Depending on the accounting date of the business, this could bring almost up to two years’ profits into charge for the year: businesses with 30 April year-ends could be particularly impacted. Given this could lead to a significantly increased tax bill, the proposed changes provide for the excess profit to be spread over a period of five tax years to mitigate the cashflow impacts (although individuals can elect to be taxed on the transition profit in any way they choose over the five spreading years – including on the full amount in 2023/24 if they wish).
Mr X is a sole trader. He draws up his accounts to 30 April each year, and profit for the 12 months to 30 April 2023 is £100k.
Under Current rules
For the 2023/24 tax year:
- Mr X basis period would be - 12 months to 30 April 2023, and
- Mr X would be taxed on £100k profit in 2023/24 tax year
Under new transitional rules
Under these proposals, on the transition to the tax year basis in 2023/24, Mr X would be taxable on:
- Profits of the 12 months to 30 April 2023, plus
- 11/12ths of the profits to 30 April 2024.
This brings the profits taxed into line with the tax year basis to 31 March 2024, but results in 23 months of profit being taxed in the transitional 2023/24 tax year. Mr X may have overlap profits to deduct from this, but it may result in a high tax liability in 2023/24 tax year. It will be possible under transition rules to spread this over 5 years with good planning to ease the cash flow burden.
What action can taxpayers take?
If your sole trade business or partnership has an accounting year end that does not align to 31 March/5 April, it is important to seek advice to understand if it is beneficial to move your accounting period to 31 March/5 April, looking at the tax implications, compliance implications and any commercial implications. For many businesses, moving to 31 March/5 April year-end will make sense to ease the burden of calculating taxable profits across two accounting periods and the additional work that may come along with estimating figures each year and then making amendments.
It is also important to review how these changes will affect your tax position as a sole trader or partner of a partnership and whether any planning can be looked at to mitigate these changes, such as:
- Moving your year-end to 31 March/5 April a year early (in the 22/23 tax year) if calculations suggest it saves you tax.
- Looking at whether it is beneficial to spread the tax on these changes over five years in line with suggested legislation.
- Making tax-efficient investments in the year of change, such as pension contributions or EIS/SEIS/VCT investments, to lower the tax burden that results.
Critchleys have been helping sole traders and partnerships with tax planning for decades and have the expertise to assist with these changes. Get in touch, and our experts will guide you and advise you to lower the tax and administrative impacts of these changes.
First Published 14 October 2022
Last Updated 06 March 2023
06 March 2023
Making Tax Digital launch date updated to April 2026
14 October 2022
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