The importance of planning to reduce your tax charge
What is it?
The way that that unincorporated businesses (sole traders and partnership) are taxed is changing. For decades, unincorporated businesses have been assessed for income tax on an accounting year basis, and businesses were free to choose their own accounting period within reason.
The government has announced that unincorporated business will be taxed on a tax year basis which means, in effect, all unincorporated businesses will be taxed for yearly profits to 5 April (or 31 March if preferable). This will be the case even if these businesses continue to complete accounts to a yearend not aligned to the tax year.
HMRC announced a delay to proposed changes to basis period reform also delayed until April 2024 at the earliest with the transitional period running in 2023-24.
Who is it for?
The changes will primarily affect unincorporated businesses that do not draw up annual accounts to 31 March or 5 April, and those in the early years of trade. If your business already draws up accounts to 31 March or 5 April, these changes will not affect you.
This will also be of interest to:
- Self-employed traders, including individuals with a profession or vocation,
- Partners in trading partnerships,
- Other unincorporated entities with trading income, such as trading trusts and estates and non-resident companies with trading income charged to Income Tax.
One of the main reasons these rules are changing is due to Making Tax Digital being brought into place from 6 April 2024 when unincorporated businesses will be required to file quarterly returns with HMRC. For more information on Making Tax Digital, see our other helpful briefing here.
How does it work?
Under the current rules, businesses are taxed in reference to their accounting profit, except in the first year of being a sole trader or partner where profits are taxed twice if the accounting period is not 31 March or 5 April. The amount of profits that are taxed twice are recorded as ‘overlap profits’ and these overlap profits are relieved either when the trade ceases or if the business changes its accounting period.
Under the new rules, once launched businesses will be taxed on a tax year basis which means a forced change of accounting period for tax purposes to 31 March or 5 April. Profits will likely again be taxed twice with relief for the ‘overlap profit’ mentioned above.
This may cause an issue where business owners have low ‘overlap profits’ and could result in higher than normal tax liabilities when the changes come into place. This is likely to be the case where profits were lower at the time a business started or when a partner joined a partnership compared to profits in the year of change. From a tax liability and a cash flow point of view, these changes could have significant impacts for unincorporated business owners and partners.
The government is proposing to bring in an election to spread the additional liabilities or ‘excess profits’ over a five year period which will help some business owners.
What should I do next?
If you are a sole trader or partner in a partnership with an accounting yearend that is not 31 March or 5 April, it is important to seek advice. It may be the case that you can change your accounting period sooner to lower the tax burden these changes will cause. This will be helpful for a lot of businesses whose profits have been affected by the pandemic. Even if this is not possible or beneficial, seeking advice soon will help you plan for the changes and the tax/cash flow implication they will cause your business.
If you would like our help or advice on Income Tax: basis period reform, don't hesitate to get in touch with Ian Timms, our Tax Partner.
First published 10 September 2021
Last Updated 6 October 2021
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