Basis period reform, the rush to 31 March
HMRC has responded rapidly to concerns over the complexity of taxation for trading and property income for income tax in the run up to quarterly submissions under Making Tax Digital (MTD). Will the proposed rule changes mean many businesses change their accounting date to 31 March? And what impact could this have on businesses and advisers?
Simplifying the system for MTD
A key reason for making radical changes now, is to make MTD for income tax (MTD ITSA) easier.
Under MTD ITSA, from April 2023, unincorporated business with turnover/gross income over £10,000 will be required to file quarterly updates. A key advantage of the quarterly returns is intended to be greater certainty over the tax position.
But complex rules on how profits are allocated to tax years meant that this was not easily achievable for individuals or partners with multiple income sources and accounting year ends other than 31 March/5 April. Hence, a change before MTD ITSA arrives makes sense.
On the other hand, the consultation review process is shortened. And the date for mandating MTD ITSA trading and property income is unaltered, except for a limited number of exclusions, such as LLPs.
Short consultation timescale
There is only a very limited period for consultation on the proposed changes to the basis period rules before they are incorporated in the next Finance Bill. The consultation opened on 20 July and closes on 31 August 2021.
Draft legislation: Tax year basis replaces current year basis
The draft legislation and consultation paper will replace the existing rule for trading income, called ‘current year basis’, with a new ‘tax year basis,’ described below.
The current year basis means taxable profits for a tax year are normally based on the accounting period ending in a tax year. Thus, accounting profits to 30 September 2020 are taxed in the tax year 6 April 2020 to 5 April 2021.
With the proposed changes, tax would instead be payable based on the profits of the tax year: the tax year basis.
Unless the accounting date is 31 March / 5 April, this means that two years’ accounts would normally need to be apportioned.
So, with a 30 September year end, for the tax year 6 April 2023 to 5 April 2024, the apportionment would be 6/12 of the year to 30 September 2023, plus 6/12 of the year to 30 September 2024.
For some businesses, this could mean estimating figures 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 would revise their tax return once figures for the second year become available.
Proposed start date
The proposal is that for all businesses chargeable to income tax on trading income, the move to the new system takes place from 6 April 2023.
From then on, the tax year basis would apply. The tax year 2022/23 would become the transitional year.
Consequences
Change of year ends
Unincorporated businesses could feel driven to change their accounting date to 31 March, to avoid the need for estimated returns and revisions.
Playing catch up: Higher tax bills
For unincorporated businesses which don’t have a 31 March/5 April accounting date, more months of taxable profit fall into the 2022/23 tax year.
Thus, a business with a year end of 30 September 2023 would need to include the 12 months of that year, plus the period 1 October 2022 to 31 March/5 April 2023 (18 months in all) as taxable profits for 2022/23.
Fortunately, there is a relief, overlap relief, to compensate. However, in most cases, tax bills will be higher in 2022/23. HMRC proposes that businesses could spread the additional profit over up to five future years.
Need for estimates
In the consultation paper, HMRC suggests that around 93% of sole traders and 67% of trading partnerships draw up their accounts to 5 April or 31 March (para 1.2). It suggests around 3% of sole traders and 15% of partnerships would need to use estimated figures to complete their tax returns. These are predominately businesses with accounting dates later in the tax year.
HMRC figures include unrepresented taxpayers. In fact, it is likely that taxpayers with agents will have more complex affairs. This could suggest that the number of businesses with advisers not using 31 March/5 April accounting dates and needing to submit estimates would be proportionately higher.
Large partnerships, those with overseas interests and seasonal businesses (e.g., tourism and farming) may also form a significant cohort of businesses whose year ends don’t align with the tax year.
Your experience
ICAS would like your view on the proposals, especially given the very short consultation timescale:
- How will businesses and advisers respond?
- Will we see a rush to 31 March year ends?
- What might this mean for professional firms in terms of workload?
- How will businesses manage additional tax payments resulting from the transition year?
- Is the use of estimated figures with revision the best approach?
- For those currently not using 31 March/5 April year ends, how many are likely to keep their existing year end?
Conclusion
The direction of travel is undoubtedly sensible. But the pace of change, in the aftermath of the pandemic particularly, places significant additional burdens on businesses and their advisers.
The timescale for responding to the consultation is short. Please let us have your views by emailing tax@icas.com.