When will the tax year basis take over from the current year basis for assessing tax on profits?
A Budget policy paper confirms that the switch from the current year basis to the tax year basis will happen for all self-employed individuals and partners from 6 April 2024.
In evidence to the House of Lords Finance Bill sub-committee on 28 October, an HMRC spokesperson said the change to the tax year basis was critical to MTD, as without it the quarterly reporting under MTD ITSA would not provide a meaningful estimation of the tax due by the business for the year.
How will it work?
Under the tax year basis all unincorporated businesses will be taxed on the profits arising in the tax year, rather than the profits that are made in the accounting period that end in that tax year (the ‘current year’ basis).
This change will affect unincorporated businesses that do not currently draw-up their accounts to 31 March, 5 April, or a date in between, and they will find their taxable income is accelerated.
The abolition of the current year basis was originally proposed to take place in 2023/24 with a transitional year in 2022/23, to align with the start of MTD ITSA. However, with MTD ITSA delayed for another year to 2024/25 so has the commencement of the tax year basis.
The transitional year will now be 2023/24, which could mean double taxation for some businesses as they will be taxed on more than 12 months’ of profits (see example).
If the business has any overlap relief from when the business started, or changed accounting period, these overlap profits will be available to off-set against profits in the transitional year.
I understand that there will be more flexibility to use this overlap relief than was set out in the draft legislation published in July 2021. HMRC said in evidence to the House of Lords that it is exploring how to communicate the overlap relief figures to taxpayers.
Where the overlap relief does not eliminate the additional profits taxed in 2023/24 the taxpayer will have the option to spread that additional profit from the transitional year over five years.
John makes a regular profit of £48,000 per year and he draws up his accounts to 30 September. In 2023/24 he will be taxed on:
|Year to 30 September 2023:||£48,000|
|Period: 1 October 2023 to 5 April 2024||£24,000|
|Total profits assessed, subject to overlap relief:||£72,000|
During the consultation on the tax year basis many commentators pointed out that the bunching of profits in the transitional year and the spreading into the next five years could have a detrimental effect on the taxpayer’s entitlement to the personal allowance, pension annual allowance, the HICBC and student loan repayments.
I understand that the government is seeking to address these unintended consequences through changes to the draft legislation which was published in July.
If businesses like John’s do not change their accounting period to align with the tax year end, they will have to apportion profits from two accounting periods to complete their finalisation statement (replacement for self-assessment tax return) under MTD.
This may involve estimating profits from one of those periods. HRMC estimate that 278,000 businesses will have to use provisional or estimated figures on an on-going basis.
The Budget impact assessment revealed that the switch to the tax year basis is expected to raise £1.715bn in extra tax over the tax years to 2022/23 to 2026/27, and further unquantified amounts of accelerated tax will be paid over the following two years. There will also be considerable administrative costs for those businesses affected, including familiarisation with the new basis period rules, updating software, and deciding whether to change their accounting date to 31 March or 5 April.
If you are likely to be effected by this change to the tax year basis and are considering changing your accounting date you should speak to your accountant.