In anticipation of the implementation of Making Tax Digital for Income Tax in April 2024, the recently published Finance Bill confirms HMRC’s proposals to change the current rules as to how profits are allocated to a tax year for self-employed individuals and partnerships (including LLPs). The proposal is to replace the existing current accounting year basis for trading income with a new tax year basis, from April 2024, with a transition year for 2023-24.

The current year basis means taxable profits for a tax year are normally based on the accounting period ending in a tax year; for example, accounting profits to 30 September 2020 are taxed in the tax year 6 April 2020 to 5 April 2021.

With the proposed changes, tax will instead be payable based on the profits of the tax year: with a 30 September 2024 year end, for the tax year 6 April 2024 to 5 April 2025, the apportionment would allocate 6/12 of the year to 30 September 2024 and 6/12 of the year to 30 September 2025. Unless the accounting period end is 31 March/5 April, this will mean that two years’ accounting profits will need to be apportioned for tax purposes. This may mean that estimates are required for the tax return, as figures for the later of the two years may not be available when the tax return is submitted. HMRC has proposed that such businesses will revise their tax return once figures for the second year become available.

Transition

The 2023/24 tax year will be a transition year and for unincorporated businesses which do not have a 31 March/5 April accounting date, more months of taxable profit will be taxed in this year.

Following the same example, a 30 September 2023 accounting date will lead to 18 months’ profits being taxable in 2023/24: the 12 months to 30 September 2023 and the period from 1 October 2023 to 31 March/5 April 2024.

Overlap relief may apply, but in many cases, there will be increased tax liabilities for 2023/24. Any excess profits arising during the transition year will be treated as a one-off separate item of taxable income, rather than as part of a business’s normal trading income.

The ‘excess’ transition profit may be spread over up to five future years, with 20% of the transition profits treated as arising and charged to tax in each tax year for four years, starting with the tax year 2023-24, with the balance treated as arising and charged to tax in the fifth tax year. If the trade ceases before all the transition profits have been charged to tax, the balance is to be treated as arising and charged to tax in the tax year of cessation.

This treatment will minimise the impact on tax allowances and means-tested benefits.

There will also be an extension to the carry-back of loss relief arising due to excess overlap relief in the transition year from one to three years. This treatment will mirror the current rules for loss relief when a business ceases and provides greater flexibility around use of excess overlap relief.

Planning ahead

If your business has an accounting year end other than 31 March or 5 April, it is important to plan ahead and consider the impact of these changes on cashflow and your annual tax compliance processes:

• Consider changing the accounting year end to 31 March or 5 April
  • Are there commercial reasons or international connections which require the current accounting year end to be retained?
  • Will significant work be required to prepare any provisional figures required if the current accounting year end is retained?
• Identify any overlap profits or losses from the tax year of commencement of the business (or first year of a partner joining the partnership)
• Estimate transitional profits for 2023-24 and the likely impact of spreading these over five tax years from 2023-24
• For partnerships, consider the impact on each partner, and amend tax retention policy to ensure sufficient cash is available to pay the annual 31 January and 31 July tax payments

Contact our Private Client Team for further details.