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Self-Employed, Sole Traders, Partnerships and the Basis Period Reforms

Self-Employed, Sole Traders, Partnerships and the Basis Period Reforms

Self-Employed, Sole Traders, Partnerships and the Basis Period Reforms

Wednesday 28 February, 2024

Did you know, your business year end may be changing?

We have spoken to local businesses in St Albans who have been blissfully unaware of the impact of this change. The tax implications could be significant. If you are unaware of the effect the year-end date change may have on your business and tax liability, we recommend speaking to a local accountant now. 

What is the Basis Period Reform for unincorporated businesses?

HM Revenue and Customs (HMRC) implemented reforms to the basis period method for taxation, which applies to unincorporated businesses and limited liability partnerships (LLPs), with effect from 6 April 2023.

These changes will affect all sole traders, unincorporated partnerships and LLPs that currently do not prepare their annual accounts to a reference date ending between 31 March and 5 April.

This is despite the delay to making tax digital for income tax and significant representation from the industry.

The key reforms involve moving from the ‘current year’ basis to a ‘tax year’ basis, meaning that business profits will be calculated for the tax year rather than for the period of account (ie their accounting year) ending in the tax year. This would align the treatment of trading income with non-trading income.

The move to this new tax year basis will involve a transitional (catch-up) year for many sole traders and partnerships that do not use 5 April or 31 March as their accounting date. This will advance tax liabilities for many, therefore it is important to seek advice from your accountant. The original proposal was to make this change from 2023/24, but the change has been delayed until 2024/25, with 2023/24 as a transitional year.

Worried about your tax liabilities due to the change?

Speak to your local accountant in St Albans. Contact Visionary Accountants on 01727 730550.

New tax year basis

Moving to the tax year basis period will require businesses to report for the 6 April – 5 April tax year for trading purposes, regardless of their actual period of account. For practical purposes, the proposed rules allow the periods to be apportioned by reference to months, if it is reasonable to do so, and this is applied consistently.

Businesses with non-tax year periods of account would be required to apportion profits or losses across periods of account to adjust their results to the tax year basis. For any periods where accounts are not yet finalised, this apportionment will require estimation and subsequent finalisation.

Phasing out overlap profits

Commencement, cessation and changes of accounting dates will no longer require the complex opening year and cessation rules, as the relevant periods will simply run to and from the end of the tax years respectively. This will eliminate ‘overlap’ profits and the need for overlap relief in the years after the changes. However, the proposed transitional arrangements do provide for use of existing accrued overlap relief. 

Transitional year

The tax year of transition will be 6 April 2023 – 5 April 2024. In 2023/24, continuing businesses will be taxable on their profits on the current year basis (ie for the 12 months to their accounting date in 2023/24, plus the period up to the end of the tax year (ie 31 March for simple apportionment). Depending on the accounting date of the business, this could bring almost up to two years’ profits into charge for the year: businesses with 30 April year-ends could be particularly impacted.

Given this could lead to a significantly increased tax bill, the proposals provide for the excess profit to be spread over a period of five tax years to mitigate the cashflow impacts (although individuals can elect to be taxed on the transition profit in any way they choose over the five spreading years – including on the full amount in 2023/24 if they wish).

Ask your accountant about the financial impact for your business.

Practical impacts

In the short term, while the rules may simplify certain technical and practical matters, firms that do not make their accounts up to 31 March/5 April will need to consider the impact of the proposed changes on their cash flow: particularly for the transitional year 2023/24 which could see partners paying tax on significantly increased amounts of profit. The impacts will continue to be felt going forward, as the changes close the timing gap between profits accruing and being brought into charge.

These changes may be particularly challenging for large professional service firms with complex financial and tax affairs, and the impacts will need to be carefully considered and prepared for ahead of the transitional year. The one-year deferral is welcome, but businesses would be well advised to make sure that they make the best use of the extra time available.

In the longer term, the reforms will remove some of the cashflow advantages of operating through a partnership model and make it harder for partnerships to finance their working capital. It is possible that some firms will want to consider the pros and cons of a move to a corporate structure in due course. 

The ongoing requirement to apportion and/or estimate profits of consecutive accounting periods may lead many businesses to consider changing their accounting date to align with the tax year. Again, this would require careful consideration, particularly for larger partnerships with complex accounting processes, and other factors would need to be taken into account. For example, some international partnerships may have a preference for a 31 December accounting date due to tax rules in other countries.

The Office for Tax Simplification is currently evaluating the pros and cons of changing the UK’s tax year end to either 31 March or 31 December, the latter being considered the more radical option, but acknowledging that there may be benefits in aligning the UK with the majority of international tax regimes. Therefore, more changes could be coming in the longer term.

Other potential impacts

There are a number of other areas of concern that arise on the transition to the new rules, many of which are not addressed to date, including:

  • Where allocations are made on a fiscal year basis, how apportioning across tax years impacts on tax adjustments, joiners and leavers who may be allocated profit for the whole fiscal year but are only a partner in one tax year, and on capital allowances claims,
  • For UK-resident members of related UK and overseas firms, whether they will have sufficient UK profits in the transitional year to utilise the previously created overlap
  • How to identify relevant foreign tax credits with the many adjustments and apportionments required.

This changeover is looking like another potential minefield. Therefore, we would strongly urge businesses affected to seek professional advice from a reputable firm of accountants in St Albans such as Visionary Accountants.

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Our team of Accounting & Bookkeeping experts will be happy to meet with you to discuss your business requirements. Complete the form below or call 01727 730550 to arrange your FREE initial consultation.

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