HMRC have launched a new consultation proposing changes to the tax treatment of the self-employed which will, if introduced, aim to simplify the manner in which their income tax liabilities are calculated.
This proposal is not a change in rate or to what is and is not taxable, rather it changes the way trading profits are allocated to different tax years. This will apply to a wide range of businesses including self-employed sole traders (encompassing individuals with a profession or vocation) and partners in trading and professional partnerships.
The Treasury suggested that the current system for determining the allocation of profits and losses made by the self-employed to particular tax years is very unwieldy and gives rise to thousands of errors and mistakes each year. They also suggest it can be unfair as two businesses which operate in exactly the same manner may need to pay different amounts of tax in any given tax year just because their accounting periods end on different dates.
Under the current system, tax returns filed by the self-employed and partnerships are based on a business’s accounts ending in the tax year (known as the “current year basis”) rather than the profits actually arising in that tax year (known as a ”tax year basis”).
Specific rules currently determine the reference period (known as a “basis period”) by which the business is taxed in certain cases, including during the early years of trading. These rules can create overlapping basis periods in the early years of trading, which tax the same profits twice and generate corresponding “overlap relief” which is usually given on cessation of the business, often many years down the line.
This Government proposal moves the self-employed on to a tax year basis with effect from 2023-24, removing the basis period rules and preventing the creation of overlap profits. On transition to the proposed tax year basis in the tax year 2022-23, all businesses’ basis periods would be aligned to the tax year and all outstanding overlap relief would be given. The twist would seem to be that this alignment may result in more than 12 months’ profits being taxed in 2022-23, even after the deduction of the overlap profits.
These changes will affect businesses which draw up their annual accounts to a date other than 31 March or 5 April. The effect of these proposals on any particular business will be complex and will depend upon whether profits are rising or falling, what the particular accounting period end date is currently and whether the sole trader or partnership has ever previously changed their accounting period end. Some businesses may want to change their accounting year end to simplify reporting. Those which do not change to a 31 March year end will potentially face additional work in determining taxable profits for the year for tax return preparation purposes.
The proposals are already fairly well developed and HMRC have published draft legislation for review alongside the consultation itself. This includes provisions which deal with the transition from one system to another. Unfortunately, the current draft legislation seems at odds with the commentary in the consultation itself. It really is not clear what HMRC are trying to achieve here and who will or won’t benefit from these new rules.
The Chartered Institute of Taxation (the “CIOT”), of which we as a business and many of our staff individually are members, has welcomed the reforms but expressed concern about the speed at which they are being introduced.
“Six weeks during the holiday season, in the middle of a pandemic, is not sufficient for tax professionals and others to assess the detail of this significant change, how it will affect them and their clients, and provide constructive feedback to government on it.”
The CIOT and the Association of Tax Technicians have both suggested that any changes should be delayed by at least a year.
What is clear is that taxpayers generally find the overlap profit rules confusing and frustrating so abandoning them will be welcome. Whether it actually saves taxpayers time and effort however, seems questionable given that additional accounting work may be required to adjust from accounting profits for the accounting period to taxable profits for the tax year.
We anticipate that individuals who are self-employed or members of a partnership will want to keep abreast of how these proposals develop and we will keep you updated. We expect that the proposals may change between now and when the final legislation is published so we suggest we “wait and see” for now. However, please do not hesitate to contact us if you would like more information on how these proposed changes could potentially affect you and your business.
