Under the current rules, unincorporated businesses are taxed on what is known as the ‘current year basis’ – for example:
If your business prepared accounts to 5 April 2021, any profits or losses will be assessed in the tax year to 5 April 2021 (the 2020/21 tax year), with your tax return and any tax due by 31 January 2022.
- However, if your business prepared accounts just slightly later, for the year to 30 April 2021, any profits or losses will be assessed in the tax year to 5 April 2022 (the 2021/22 tax year), with your tax return and any tax due by 31 January 2023.
- If your accounting year is anything other than 5 April, you will have had some double counting of profits when you started in business. A figure of ‘overlap profits’ should have been calculated at the time and you can claim relief for that amount when you either change your accounting date or cease trading.
HMRC want to ‘simplify’ matters so that you will be assessed on a ‘tax year basis’, so that the results of that year are taxed in that year, regardless of your accounting date. They also want to remove the need for ‘overlap profits’ to be calculated. The main driver for this is the planned introduction of Making Tax Digital (MTD) which is due to be introduced for income tax in 2024, but you can see that it also means that profits will be taxed sooner.
That will be fine if your accounting period is already 5 April or 31 March, but not so straightforward if it’s anything else. In those cases, the 2023/24 tax year will be a transitional year when two accounting years are taxed, so that you can catch up, and by 2024/25 you will be within the tax year basis.
This is an issue which makes more sense with some numbers, so let’s look at an example where your unincorporated business has accounts prepared to 30 April each year, and you make tax adjusted profits of £55,000 in the year ended 30 April 2023 and £66,000 in the year ended 30 April 2024. The overlap profits brought forward amount to £20,000 in this example.
What will happen in the 2023/24 transitional year?
- Your profits for the basis period (accounting period) ending in 2023/24 (30 April 2023) are £55,000.
- You add your profits for the period from the end of that basis period to 5 April 2024 - £66,000 x 11/12 months = £60,500.
- You then deduct your overlap relief of £20,000.
- Your taxable profit for the year is £95,500, being £55,000 + £60,500 - £20,000.
- Since the additional profits calculated at (2) are greater than the overlap relief at (3) by 40,500. You can elect to spread this amount over up to five years, so £8,100 each year.
- Assuming an election is made, your taxable profit for 2023/24 will reduce to £63,100, which is required to be reported on your 2024 tax return, due by 31 January 2025 together with any tax payable.
What will happen in the year following the transitional year?
In 2024/25 you will need to report the taxable profits for the year ended 5 April 2025, regardless of your accounting period year end. You will have to remember to increase your profits for each of the next four years (by £8,100 in our example) if you have elected to spread the transitional year profits.
If you have an accountant, they will be able to deal with the number crunching and the reporting on your behalf, but this will still present you with several problems, such as:
- When will you know what your profits are for the subsequent accounting period falling after the end of the tax year and when can you get them to your accountant? In our example, for the year ended 30 April 2024, you will need to be able to estimate a figure probably during the summer/autumn of 2024.
- Have you kept a record of any overlap relief you can claim? This will be particularly important if this was a high figure as this will reduce your taxable profits. There’s also a new relief which allows you to carry back excess overlap relief for three years.
- Your profits may be substantially higher in 2023/24. The legislation has been amended to lessen the impact of this on your allowances and any means-tested benefits but what impact will this all have on your tax bill?
- What happens if you make losses?
- If you continue with your current accounting period year-end, there will be additional administration preparing or reviewing a later set of accounts every year. This is likely to take extra time and incur extra costs.
- If you use an estimate, you may be required to amend your tax return once your accounts are finalised. This has yet to be confirmed by HMRC but again, this could incur time and costs.
One option to avoid the problem would be to change your accounting year end to either 31 March or 5 April – and that is certainly what HMRC would prefer. There are special rules which apply when you do this so you should talk to your accountant about this. In particular, you need to know whether it is better to change now or wait until the new rules come into force.
However, a change of accounting date may not work for your business – perhaps you’re an industry such as hospitality or farming, where it’s better to wait for the end of the ‘season’ to prepare accounts, or maybe your profits come from a partnership interest where you have no control over the accounting period end. If there’s a good reason not to change, it will be even more important to establish a way to deal with the extra reporting that the new rules will bring.
The draft legislation already includes some changes made following feedback and HMRC has said that they will continue to explore options to minimise the burdens of the extra reporting but, with these rules around the corner, and MTD to come, the best advice is to speak to your accountant well in advance so that you can all plan accordingly.