The basis for change
Sharon Cooke raises issues regarding the proposed changes to the basis period rules for tax reporting.
While we await updated draft regulations for Making Tax Digital for Income Tax, HMRC threw a curveball in July 2021 with a consultation, supported with draft legislation, about changing the rules for basis periods to enable the digital requirements.
Making Tax Digital for Income Tax is due to commence in April 2023 for those with taxable turnover from their self-employed business and/or income from their property business of more than £10,000. Key to this regime is the requirement to submit quarterly summaries of business income and expenditure to HMRC. Initially, the plan had been for the quarterly submissions to be aligned to the accounting period, but concerns have been raised about the number of times those with several sources of income would need to report their income under Making Tax Digital for Income Tax.
The basis period consultation has now closed but put forward the premise that businesses would simply be taxed on profits arising in a tax year, aligning the way self-employed profits are taxed with other forms of income, such as property and investment income. The transition away from current year basis would take place from 2022/23, ready to then apply a tax year basis in 2023/24.
As part of the proposed simplification, the statutory rule that deems the equivalence of 31 March to 5 April in the first three years of a trade would be extended to apply to all years of trade. As such, proposed changes to basis periods would affect all unincorporated businesses that do not draw up annual accounts to 31 March or 5 April.
A sole trader draws up accounts to 31 May every year.
Under the current year basis rules, income tax for 2023/24 would be based on the taxable profits arising in the year ended 31 May 2023.
Originally, we had expected Making Tax Digital for Income Tax to apply for periods commencing on or after 6 April 2023. For this individual, the rules would therefore first apply to their trading profits for the period from 1 June 2023 to 31 May 2024. The first quarterly submission of trading results would have been for the period from 1 June to 31 August 2023.
Under the proposed reform, a tax year basis would apply in 2023/24 meaning that the income tax charge on trading profits would be based on:
- 2 months from the accounting year to 31 May 2023
- 10 months from the accounting year to 31 May 2024
How results are apportioned for each accounting period would likely be on a time basis (in days), but the self-employed individual could apply other reasonable approaches.
The consultation envisions the Making Tax Digital quarterly reporting also aligning to the tax year. For this individual (and indeed all self-employed individuals), the reporting rules would therefore potentially first apply to the period from 1 April to 30 June 2023.
If commercially acceptable, the sole trader would be able to change their accounting year end to 5 April or 31 March to simplify their tax position but there would be no legal requirement to do so.
The consultation acknowledges that businesses with accounting dates later in the tax year may not have their second set of account and tax computations prepared in time to meet filing deadlines. In these scenarios, the businesses would be expected to use provisional figures to make their tax submission and then submit an amendment once the final figures are known.
Turning to the transition in 2022/23, for those businesses with an accounting year other than 31 March or 5 April, the basis period for the transition year would be determined by adding together two components:
- the standard component, defined by the current year basis for the transition tax year,
- the ‘transition component’, running from the end of the basis period for the tax year to the end of the tax year itself.
Any overlap relief due to the individual would then be deducted in 2022/23.
Where excess profit (attributable to the transition component less overlap relief) arises in 2022/23, this could be spread equally over 5 tax years, starting with 2022/23.
In 2022/23 the sole trader would be assessed on:
- Taxable profits (or losses) arising in the year to 31 May 2022; plus
- 10 months of the taxable profits (or losses) arising in the year to 31 May 2023; less
- Any overlap relief due
If we assume that (2) less (3) gives excess profits of £15,000, £12,000 of this would be deferred by way of the spreading rules, with £3,000 then coming into charge in each tax year between 2023/24 – 2026/27.
The London Society of Chartered Accountants Taxation Committee responded to the consultation and strongly advised against the timeline set out above (see copy of full submission here).As all readers are already inevitably thinking; the above scenarios throw up a wide range of very practical issues that must first be addressed.
While very little has yet been said by HMRC in response to the feedback on basis periods, on 23 September an important announcement was made about Making Tax Digital for Income Tax being deferred; until April 2024 or, in the case of general partnerships, April 2025. Alongside this headline news it was confirmed that the proposals for basis period change would not come into effect earlier than April 2024 (with a transition in April 2023). This is welcome and shows that responses, such as those made by the LSCA Tax Committee, do make a difference. Now we await the Budget on 27 October 2021 to see if a more detailed plan around basis periods is shared.
Sharon Cooke FCA CTA is a Director and tax consultant with Mercia Group and a member of the LSCA Taxation Committee.