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Key points
- Changes to basis periods for the self-employed, partnerships and LLPs, has now been postponed by a year to 6 April 2024.
- The current year basis will be termed an earnings basis or tax year basis so profits attributable to that tax year will be time apportioned.
- Criticism includes that it is costly and complicated, would adversely affect sole traders and seasonal businesses and its lack of clarity for partnerships and multiple trades for a single taxpayer.
- There are concerns about how a change in basis period would fit into the overall timetable for MTD.
- The deferral will enable a more robust pilot programme and for HMRC to focus on customer support and invest in digital technology.
- Rules would need to be adjusted to take into account the artificially high income assessed in the transition year of 2022-23.
Following HMRC’s basis period reform consultation (tinyurl.com/253dfpeb) on the proposed changes to basis periods for the self-employed, partnerships and LLPs, the government decided to postpone the reform by a year. This additional time provides an opportunity for agents to raise awareness and educate their clients about making tax digital for income tax self assessment (MTD ITSA) and helps to address the issues initially raised by members of the Institute of Financial Accountants (IFA).
Released in July, the government’s consultation proposed that the basis of taxation should change from the current year basis to what will be termed an earnings basis or tax year basis. This would look first to the tax year in question, and then time-apportion the accounts so that profits attributable to that tax year are taxed in that tax year. For example, a business with a 30 April 2023 year end would take 1/12th of these profits for the tax year 2022-23, and 11/12ths of the profits for the year to 30 April 2024 to determine the taxable profit for 2023-24.
IFA’s concerns
The criticism levelled at the government’s proposed reforms to the basis period for taxation was that it was costly and complicated, while the IFA and its members voiced concerns that sole traders and seasonal businesses could be hardest hit.
Despite its support of the modernisation and digitalisation of the tax system, the IFA voiced concerns about how a change in basis period would fit into the overall timetable announced in July 2020 for MTD which includes extending VAT to all VAT-registered businesses from April 2022, and quarterly income tax reporting from April 2023 for MTD ITSA. It also cited corporation tax MTD as still requiring consultation.
The IFA stated: ‘While IFA members are largely in favour of the change to the tax year basis, as most unincorporated businesses use a 31 March or 5 April accounting period end already, there are a number of significant concerns. The roadmap for MTD will mean that many more individuals and businesses will be within the scope of MTD than before. These individuals and businesses will require help and support with the transition. Some of these individuals and businesses may not have a tax agent.
‘There is no detailed timetable of MTD ITSA and how the proposed changes in the basis period will be implemented. We strongly urge HMRC to consult on this further before proceeding.’
Following the deadline for feedback, in its response to the IFA, HMRC informed the professional accountancy membership body that the government had ‘listened to the strong views we received asking for the proposed reform (and making tax digital for income tax) to be put back by a year.’ This was confirmed in a written ministerial statement in September by the financial secretary to the Treasury, Lucy Frazer, who announced in parliament that MTD for income tax would start from 2024-25 (and 2025-26 for general partnerships), and basis period reform would not happen before April 2024, with the transition not before 2023.
The deferral will now enable a more robust pilot programme to take place and for HMRC to focus on customer support and invest in digital technology to roll out what are major changes to the tax system.
Summary of IFA’s feedback
Of the 40 IFA members who took part in the survey for the purpose of feedback to HMRC, many of them believed the change to a tax year basis would effectively push businesses into using an accounting period ending on a date between 31 March and 5 April.
However, 56% of members who responded to the survey were not in favour of the tax year end or 31 March to be mandated as the accounting period end for all unincorporated businesses – aside from the worry that ‘micro clients’ like taxi drivers would struggle to understand the changes, one respondent commented the accountancy profession ‘will bear the brunt of [client confusion] at a time when we will still likely be recovering from the effects of a world pandemic’.
A large majority of members (68%) recommended that their clients who currently do not use a 31 March or 5 April year end should change to use that accounting date. Only 17% of members would advise such clients to retain their non-tax year accounting period and apportion profits to tax years as required.
More than 90% of members agreed there would be additional costs to clients where an apportionment of profits between tax years is required, with the average cost for each client estimated to be £200 to £500 a year – although nearly a quarter of members estimated extra costs would be £500 to £1,000 a year.
Members believed that sole traders and businesses with November or December year ends would be the hardest hit, while many seasonal businesses and industries such as farming, tourism and construction which tend to have year ends in months when trade is less busy will be better able to deal with the administrative burden. They also felt that they have few resources to pay for extra accountancy help. The estimates of the cost burden for these businesses varied from £100 to £1,500, as it would depend on the complexity of the business and how different their financial year end is from the tax year end.
Members suggested that HMRC could:
- adopt 31 December as the tax year to align with most other countries;
- change the accounting period now before the next filing date;
- continue with the current once-a-year filing until the new systems are debugged; or
- not bring in MTD.
Around 15% would advise clients to ‘review the structure of their business and possibly incorporate the business’.
Nearly 44% of members preferred that there was no change in basis periods at all, although some felt the change to the tax year basis should be optional and not mandatory.
One respondent said: ‘Any reform should first address the underlying absurdity of a 5 April tax year end. Sooner or later the tax year will have to be changed. If the introduction of a mandatory accounting year was implemented simultaneously with that change, I would support it, but doing it as proposed means we are going to have two periods of upheaval instead of one.’
Other issues raised were:
- Individual partners may be involved in several different businesses and the calculation of profits in the transitional basis will be very complex and costly to compute. Detailed HMRC guidance would be needed in advance of how multiple trades and professions will be dealt with for a single taxpayer. The guidance should include the situation where some of those sources of income may be overseas partnerships.
- The reforms would mean a large extra tax liability and a potential debt burden for up to five years, which would be difficult to manage for partners that leave or join the firm in that period.
- Changes in partnership profit sharing agreements may be required, and that may result in disagreements between partners and/or legal costs.
- It could be a ‘nightmare’ for partnerships of solicitors.
- There could be possible problems with the interaction of capital allowances and annual investment allowances on the firm’s profits and profit shares.
Concerning other specific circumstances on transition to the tax year basis that would require additional rules, members emphasised that there were many charges and deductions affected by the taxpayer’s total taxable income assessed in the tax year, and rules would need to be adjusted to take into account the artificially high income assessed in the transition year (2022-23).
Members suggested the following solutions in each case:
High income child benefit charge (HICBC):
- Raise the income threshold which currently stands at £50,000. This threshold is now within the basic rate band, which defeats the objective to apply the HICBC only to higher earners.
- Disregard all the additional profits assessed because of the transition.
- Abolish the HICBC.
National Insurance contributions:
- Calculate National Insurance on the basis of 12 months’ proportion of profit.
- Disregard all the additional profits assessed because of the transition.
- If the excess profits are spread forward over five years this should also apply to the National Insurance payable in line with those carried forward profits.
- The average profit of previous two years should be the basis for assessment.
Student loan repayments:
- The loan repayment should be capped based on 12-month period proportion.
- The cap loan repayment should be based on the average of two preceding years.
- The increased profits due to transitional year should be ignored.
Working tax credits:
- Use the current year basis of profits for the transitional year.
- Any increased profits should be ignored.
- Tax credits should be renewed based on previous year.
- This should be based on a 12-month pro rata period.
Averaging of farming or creative profits:
- Set a maximum based on a 12-month proportion of profits.
- Average actual transitional year profits with preceding tax year regardless of basis of the former.
- Any increased profits due to the transition should be ignored.
In the autumn Budget, the chancellor confirmed that the reform of basis periods will be implemented, with a transitional year in 2023-24 and the new rules applying from 2024-25 onwards. Further details can be found at: tinyurl.com/3f7afeys.
