TAFR gets real with consultation on basis period reform

The intention to reform basis period rules, so that trading profits are taxed in the tax year in which they arise, was flagged in the Tax Administration Framework Review (TAFR) to which ICAEW responded in ICAEW REP 65/21. However, it was not anticipated that the government would publish a consultation, which includes draft legislation, on reforming basis periods just one week after the TAFR closing date.

The unseemly haste and abandonment of the usual consultation process appears to be driven by the wish to implement any changes before Making Tax Digital for income tax self assessment (MTD ITSA) becomes mandatory from April 2023.

The proposal is that the tax year basis will apply from 2023/24, with 2022/23 being a transition year. It is not clear how these changes would fit with any change to the end of the tax year which might follow the current review by the Office of Tax Simplification. The Tax Faculty argues that it would seem sensible for any such changes to be coordinated.

ICAEW and other professional bodies have been discussing with HMRC the difficulties that the separate obligations for MTD quarterly updates for different income sources would pose. This is potentially exacerbated if it is not possible to align the quarters for all income sources (and potentially with VAT stagger periods). In particular, ICAEW identified the need to allow more flexibility for property income. The reform of basis periods does address these concerns and allows for alignment, but does it create other problems?

Potential impacts

The consultation suggests that unincorporated businesses will be taxed on the profits arising in each tax year, rather than the profits of an accounting period ending in that tax year which is the current general rule for ongoing businesses.

This change would largely go unnoticed by businesses that use an accounting date of 31 March or 5 April but could be hugely problematic for businesses that use a different accounting date, particularly one later in the tax year.

Such businesses would have to allocate profits of an accounting period to tax years and would need to do so each year, bringing significant complexity. For example, a business with accounts made up to 30 June would need to include 3/12 of the results from those accounts in its tax result for a particular tax year, along with 9/12 from the next accounting period.

It may also lead to the need for estimations as, for example, a business with a December year end would not be able to finalise its accounts in time to allocate profits to the previous tax year:

Tax year 2025/26 would be based on 9/12 of the profits for year end 31 December 2025 and three months of profits for the year end 31 December 2026. The latter set of accounts are unlikely to be finalised in time to file the 2025/26 return by 31 January 2027.

HMRC has suggested potential methods for making estimates to file the return and then amendments when the final figures are known.

The consultation suggests that 7% of self-employed trades would be impacted, and 33% of partnerships.

Other changes and transitional provisions

One aspect of the proposals that most will welcome is that either a 31 March or 5 April accounting date would be allowed for trading and property income to enable taxpayers to report both income sources together. The current limited concessions in this regard would become statutory.

It would also mean the end of overlap relief which does present a simplification. In its response to the consultation, ICAEW will be arguing that HMRC must provide figures for available overlap relief to businesses and agents so that any relief for double taxation in the year of transition can be calculated.

For some businesses, the change to a tax-year basis would mean a significant additional tax bill in the transitional year on profits that are taxed to “catch up” on the proportion of the basis period not taxed in the previous tax year. For example, businesses with a 30 April accounting date where the extra income to be taxed in the transition year would not be significantly offset by overlap relief where business profits have grown over time.

However, transitional provisions would provide for the spreading of transition-period profits over five tax years, starting with the 2022/23 tax year, with the option to accelerate. This would carry the risk of tax and national insurance rates increasing during this period.

Share your view

The issues that immediately spring to mind on which the Tax Faculty would like members’ views include:

• Would businesses change to use a 31 March or 5 April accounting date?
• Would the changes be workable for businesses that, for commercial reasons, cannot or would prefer not to make such a change?
• It is likely that MTD quarterly updates would need to fit within the tax year. This would probably cause bunching of agents’ workload to meet April, July, October and January deadlines. What impact would this have on firms?
• Businesses might also wish to change their VAT stagger group to fit with the calendar quarters for income tax, though some might choose to keep them separate to spread their workload. How might businesses and agents respond to this?   

The consultation on basis periods runs until 31 August and ICAEW’s Tax Faculty requests that members send their comments to anita.monteith@icaew.com by 10 August.