Finance Bill 2021-22 includes legislation aimed at simplifying the way in which the profits of unincorporated businesses (including trading partnerships) are taxed. Whilst on the face of it, the ‘basis period reform’ is a very dry and technical subject which most business owners might feel inclined to leave to their accountants, the changes actually have wide reaching cash flow implications and potentially significant administrative costs for all unincorporated businesses (except those that already prepare their accounts to 31 March or 5 April).
The changes were first proposed last summer and, following a period of consultation, were expected to come into effect from 2023/24. Implementation has since been pushed back a year to 2024/25 (in line with the delay to Making Tax Digital), with 2023/24 being the transitional year. This delay gives business owners some time to look ahead and plan accordingly, particularly where cashflow is concerned.
The current position
Under current rules, unincorporated businesses are taxed on the profits of their 12-month accounting period ending in the tax year, with special rules applying in the opening and closing years or where there is a change to the accounting date.
For example, if a business draws up its accounts to 30 September, in the 2021/22 tax year it will be taxed on the profits for the year ended 30 September 2021.
The current rules are complicated, particularly in relation to the opening years of a business (or when a new partner joins a business) and often result in some profits being taxed twice in the early years, creating what is known as ‘overlap profits’, which can then be offset on a change of accounting date or on cessation (or where a partner retires). Whilst this offset, known as ‘overlap relief’, ensures that the business is effectively only taxed once on its total ‘lifetime’ profits, the rules can have a negative impact on cashflow. However, the existing rules do of course allow for a significant deferral of tax when profits are rising (particularly for a business with a 30 April yearend).
The proposed changes
The proposal is that from the 2024/25 tax year, all unincorporated businesses will be subject to tax on the profits arising in the tax year (irrespective of what date their accounts are drawn up to), aligning the treatment of trading income with non-trading income.
This will require those businesses with year ends other than 31 March or 5 April to apportion their profits for 2024/25 onwards using a pro-rated proportion of the accounting periods falling partly in each tax year. It will also mark the end of overlap relief and all the disadvantages and complexities that come with it!
The 2023/24 tax year will be a transitional year (‘catch up’ year) in which business will be assessed on the following profits:
- The profits of the accounting period ending in the tax year
- The profits from the period starting immediately after the end of that accounting period to 5 April 2024
Using the example again of a 30 September year end, this would result in the profits of the year ending 30 September 2023 and the period 1 October 2023 to 5 April 2024 (i.e., 18 months’ profit) all being taxable in 2023/24.
Any overlap relief brought forward will be offset against the 2023/24 profits (with no option to defer the claim). If the profits assessable in 2023/24 are higher than they would have been under the old rules (which they will be if the business is more profitable now than it was when the overlap profits arose), the additional amount can be spread over five tax years (including 2023/24) and taxed accordingly, although individuals will be able to elect to bring additional amounts into charge in any of the first four years, if they so wish e.g. to regulate their tax payments year on year or to create a level of certainty with potentially increasing future tax rates. If the business ceases before all the additional profits have been taxed, then these come into charge in the year of cessation.
Points to consider
Both immediately and over the next few years, businesses will need to consider several issues, including:
- The merits of adopting an accounting date of 31 March or 5 April going forward to align with the tax year – care needs to be taken over the timing of any change to ensure that the business can benefit from the ‘spreading’ provisions
- The timing of accounting and tax computation work – tax returns may need to include estimates and then be amended at a later date
- The cash flow implications of the changes (particularly in the transitional year – tax payable January 2025) and the merits of spreading the transitional profits over five years
If you have any questions on how these changes might impact on you then please get in touch with me.