Basis periods to be abolished (unincorporated businesses)

By Charlie Thompson, Tax Consultant

Charlie Thompson, Tax Consultant

Since self assessment started in 1996, unincorporated business (i.e. sole traders and partnerships) have been assessed to income tax on the current year basis. This means essentially that your tax is based on the accounting year end falling in the tax year.

The accounts could be drawn up to any date within the tax year, within reason. The way the rules applied meant that some profits were taxed twice at the start of a business and relief was given for this when the business ended (this is called overlap relief).

The Government have announced plans to change this with effect from 6 April 2022 for a variety of reasons, but mainly because of Making Tax Digital (or MTD) coming into effect for income tax on 6 April 2023. Under MTD, reports are made to HMRC through accounting software every quarter. Without this change, where taxpayers have different sources of income, even more reports would have been required under MTD.

The Government intend to replace the current year basis with the tax year basis. In effect, all unincorporated businesses would prepare accounts to 5 April (or 31 March if preferable) each year. This can be done by keeping the same accounting date and estimating the missing period to the end of the tax year. In practice we anticipate most business choose to prepare accounts to the end of the tax year.

In addition, in the first year, there may be tax paid on up to two years profits.  For example, if you currently draw your accounts up to 30 April, your income tax bill for the 2022/23 tax year would be based on your profits for the year to 30 April 2022 plus your profits for the period from 1 May 2022 to 5 April 2023.  If any overlap relief is available from when the business commenced that can be used to reduce the profits taxed in the year. In addition, there will be a transitional relief to spread the excess profits that would be taxed in the transition year over five years. If the business ceases to trade in that five year period, then the amount remaining comes into charge.

This change only affects unincorporated businesses but corporate partnerships may also have complications.

As this is only a consultation at this stage and still subject to change, we recommend considering the impact on your business (particularly the effect in the first year) and checking to see the extent to which you are entitled to overlap relief.  Understanding this will allow you to assess the cashflow impact of paying tax earlier.  If you would like further information on the new rules or assistance in understanding the cashflow impact of the changes please contact your usual contact at the firm or Charlie Thompson in our Consultancy team.