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Income Tax basis reforms – Getting ready during the transition year

From the tax year 2024/25 onwards, any unincorporated businesses, including sole traders, self-employed persons, and trading partnerships, will be subject to taxation on the profits they generate within the 12 months ending on either 5 April or 31 March.

Here are the important changes to take note of:

Current system

Currently, unincorporated businesses, such as self-employed sole traders, are subject to taxation on profits earned within their accounting period that concludes in a particular tax year.

The law does not mandate unincorporated businesses to create accounts or set a specific date for doing so, thereby enabling them to select any accounting date of their choice.

As a result, a business’s profit or loss for a tax year typically aligns with the profit or loss up until their accounting date, commonly referred to as the basis period. During the initial trading years, certain regulations dictate the basis period.

In cases where the accounting end date does not fall on 5 April or 31 March (which are equivalent to 5 April) the rules can produce overlapping basis periods that impose tax on profits twice, resulting in the creation of “overlap relief” when the business ceases.

The differing rules for trading profits in comparison to other types of income, such as dividends and property income, which are taxed based on the tax year, may confuse certain taxpayers.

The changes

The proposed reforms will modify the basis period for all unincorporated businesses by shifting it to the end of the tax year, currently designated as 5 April.

This change will necessitate interim arrangements for businesses without year-ends falling between 31 March and 5 April every year.

Such businesses may face a single, larger tax bill for their profits arising from the year-end falling on 5 April 2024, during the 2023/24 tax year.

Businesses with accounting period end dates that differ from the end of the tax year will need to apportion profits/losses and may require the use of provisional figures in their tax returns if they have not prepared accounts and tax computations for subsequent accounting periods before the tax return filing deadline.

Reliefs, allowances, and tax band thresholds will remain unaltered and will not be pro-rated, which could lead to certain taxpayers moving into higher tax bands while reducing their ability to benefit from various annual reliefs and allowances, potentially resulting in the loss of child benefits. Paying pension contributions in 2023/24 could reduce these problems.

Businesses with year-ends that do not align with the tax year will have a shorter period between generating profits and when taxes become due, which may have cash flow implications.

To address the potential impact on taxpayers, the additional profits arising in the transition period will be spread equally over five years by default.

However, taxpayers can elect for an additional amount of those profits to be treated as arising in the tax year in which the election is made.

Moreover, HMRC will regularly offer Time to Pay arrangements to those requiring more extended payment schedules.

Businesses can also use all accrued overlap relief created when they began trading during the transition year (2023/24).

This implies that such businesses will only have a tax liability on 12 months’ profits. However, the overlap relief dates back to the first year of trading, during which the business is likely to have been less profitable.

In the future, when these new regulations come into effect, new businesses will not generate overlap relief, and no specific regulations will be necessary for starting, ceasing, or changing the accounting period end date.

Non-trading income remains unaffected by these changes, as it is assessed on a tax-year basis. For the numerous unincorporated businesses with year-ends synchronised with the tax year, including those between 31 March and 5 April, nothing will change.

However, for those with year-ends not aligned with the tax year, careful tax planning may be necessary, considering several factors.

How we can help

Businesses should be prepared for these changes to be implemented in future and have suitable plans in place that reduce the impact of this substantial amendment to the tax rules.

These changes, when implemented, are likely to have a significant impact on unincorporated businesses, leading to higher tax bills and costs without careful planning.

Worried you may be affected by these reforms? Find out how we can assist you.


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