HMRC have recently published a consultation document on ‘basis period reform’. To be clear, that is not consultation on whether to do it or when to do it: just on how to do it.
It will affect only sole traders and partnerships who draw up their annual accounts to a date other than 5 April or some close approximation to it such as 31 March. Relatively few sole traders are in that position: but around one third of partnerships will be affected.
Take, for example, a business with a year-end of 31 December. Under the current rules, tax for the tax year 2021/22 is assessed by reference to the profits (as adjusted for tax purposes) of the year ending on 31 December 2021. The proposal is that starting from the tax year 2023/24, tax will be assessed by reference to the profits of the tax year itself: so for 2023/24 the charge will be on the profits of the year ending on 5 April 2024.
Where does that leave the profits of the period 1 January 2022 to 5 April 2023, you may ask? Surely HMRC aren’t going to levy tax in 2022/23 on 15 months’ profit? Well, yes, they are actually: but it’s not quite as bad as it seems.
For one thing, the taxable profit will be reduced by ‘overlap relief’. The technicalities of when and why overlap arise are unimportant. Much more relevant is the fact that generally speaking it will not fully compensate for tax on the additional profit. Very broadly, the longer the business has been trading, the smaller the effective benefit of ‘overlap relief’.
That brings us to the second ‘relieving’ factor: any increase in taxable profits resulting from the change of basis can be spread for tax purpose over the five tax years 2022/23 – 2026/27.
Although there will no requirement for accounts to be drawn up to 5 April (or 31 March), any business that does not do so will have to arrive at figures for the tax year by apportioning the profits of periods for which accounts are drawn up. Depending on the accounting date used, this may initially require estimates to be made: HMRC suggest that this will be necessary for around 15% of partnerships. So unless there is a very good commercial reason for choosing a different accounting date, most businesses will no doubt want to avoid that additional cost of apportioning by switching the accounting date to 31 March or 5 April.
For more on the change and how BKL can help you to prepare for it, please get in touch with your usual BKL contact or use our enquiry form.