Paraplanners are perhaps more concerned with income tax basis periods as an exam topic than as an advisory issue … but that might change, says Gerry Brown.
HM Revenue & Customs (HMRC) has been consulting on how to simplify the rules under which profits of an unincorporated trading business are allocated to tax years.
The general rule is that the ‘basis period’ for a tax year is the period of 12 months ending with the accounting date in that tax year.
Assume Charlie’s Chippy, an unincorporated business, prepares accounts to 30 September every year.
Currently, the tax charge for 2023-24 would be based on the profits reflected in the accounts for the year ended 30 September 2023. The year ended 30 September 2023 is the ‘basis period’ for the 2023-24 tax year.
There are special rules for determining basis periods when a business starts or ends. However over the life of a business, the basis period rules ensure that all profits are taxed once and only once.
When a business starts some of the profits will be taxed more than once but this is remedied when the business ends by granting a deduction (known as overlap relief) for those profits which have suffered double taxation.
In its consultation HMRC has argued that;
“… the system has created a complex set of rules and a relief that exists purely for tax purposes. This complexity brings significant downsides for businesses, who find it difficult to understand and apply the basis period rules. The rules on overlap relief are an area of particular complexity, with most eligible businesses not claiming the relief when they should. These businesses may not know they are eligible to use relief, do not know how to calculate relief, or may have lost track of their relief over time.”
HMRC proposes that the taxable profits for a tax year would be those arising in the tax year itself – the concept of a basis period would be abandoned.
Charlie’s Chippy would have taxable profits for 2023- 2024 based on: 6/12 of the profit for the year ended 30 September 2023, plus
6/12 of the profit for the year ended 30 September 2024.
The changes would come into effect from 2023-24 to harmonise with the introduction of ‘Making Tax Digital’ for income tax.
The proposed changes will mainly impact ‘sole traders’ and partnerships. It is estimated that 97% of sole traders prepare accounts to 31 March or 5 April and will therefore be unaffected. Similarly 67% of partnerships prepare accounts to 31 March or 5 April and these too will be unaffected. (HMRC would regard 31 March and 5 April as equivalent.)
How would the change to the new regime work?
The proposed transition will take place in 2022-23 and two elements will determine the basis of taxable profits for that year.
The taxable profit for a business, such as Charlie’s Chippy, with a 30 September year end would be calculated as;
(a) The taxable profit for the year ended 30 September 2022 – the standard element; plus
(b) The taxable profit from 1 October 2022 to 5 April 2023 – the transition element.
Overlap profits from the early years of trade must then be deducted from the profits of the transitional year.
Those businesses where taxable profits for the transition tax year will be higher than if they had been calculated under the ‘old’ rules can elect to spread the ‘extra’ profits over a period of up to five years.
Where the filing deadline for a tax year arrives and no accounts have been prepared covering the complete tax year, estimates will have to be used.
Although most of this work is within the ambit of accountants, advisers could use these changes as an opportunity to develop professional connections.
Advisers should be in a position to discuss these changes, at a high level, with those clients affected and to point out that the proposals will accelerate the timing of tax their payments; there will be a shorter gap between meaning profits and paying the tax due on them.
The calculation of relevant earnings could be delayed – particularly during the transition period – and this could affect pension planning.
So although few clients will be affected, the impact on those who are could be significant.
