Changing how business profits are taxed – An alert from Ryecroft Glenton’s Agricultural and Landed Estates team

HM Revenue & Customs (“HMRC”) has announced a new consultation into the reform of ‘basis periods’ for the taxable profits of sole traders and partnerships and this may affect when or how soon your business pays tax on its profits in the future.

Published on 20 July 2021, the consultation proposes that changes be implemented from the 2022/23 tax year, but the transition to the proposed regime may well create cashflow concerns for many sole traders and partnerships, specifically those in the farming sector which is acknowledged in the Exchequer’s impact assessment.

HMRC’s Case for Reform

HMRC’s proposal involves changing the timing of when sole trader and partnership profits are taxed, moving away from the ‘current year’ basis of assessment to a ‘tax year’ basis, which effectively means that business profits will be taxed by reference to the tax year in which they are earned, rather than by reference to the accounting period or year-end of your business.

In terms of their case for reform, moving to a tax year basis of assessment supports HMRC’s general direction of travel to modernise our tax regime and to make it more efficient, specifically facilitating:

  • Further changes under Making Tax Digital (“MTD”) that are due to be introduced from 2023 which will see increases in real time reporting of business income and expenditure; and
  • Earlier collection of tax on business profits, to which HMRC’s recent call for evidence on timely payment relates and suggests that acceleration of self assessment tax payments may be on the horizon.

HMRC’s proposals are not set in stone nor guaranteed to be enacted, but we cannot help feel they will be for the reasons set out above and also because the consultation document was published alongside draft legislation, which in our view is indicative that HMRC expects reform to proceed broadly as it has set down in its consultation document.

The tax year basis of assessment

If the proposed reform goes ahead, from the 2023/24 tax year, sole trader and partnership taxable profits will be aligned with the tax year.

For businesses that already prepare their annual accounts to either 31 March or 5 April, there will be no impact.  However, most farm businesses typically prepare their annual accounts to a date other than 31 March or 5 April, with their chosen year end dictated by lambing, harvest or rent quarter dates.

For the majority of farm businesses, the 2022/23 tax year would therefore become a ‘transitional year’ in which the farming profits up to the normal accounting date will be assessed together with profits arising in the period between the current accounting year end and 5 April 2023.  For example, a farm business preparing its annual accounts to 13 May each year would be taxed on:

  • In the 2022/23 tax year – its profits for the year ending 13 May 2022 plus approximately 10/12ths of its profits for the year ending 13 May 2023; and
  • In the 2023/24 tax year – it would be assessed on approximately 2/12ths of its profit of the year ending 13 May 2023 plus approximately 10/12ths of its profits for the year ended 13 May 2024.

Beyond 2023/24 similar apportionments would be required.  The associated additional administrative burden should not be underestimated and while HMRC acknowledge this impact, their proposals as they stand do little to help.

Changing the business accounting date to 31 March or 5 April will solve the problem but for many farming businesses this may not be practical or commercially acceptable in terms of workload.

Softening the tax cost of transition

For businesses preparing their annual accounts to anything other than 31 March or 5 April, the transition into the tax year basis of assessment is likely to bring with it an acceleration of tax. 

To soften the tax cost, HMRC’s proposals put forward two relieving provisions:

  1. Phasing out overlap profits – many sole traders and partners will have suffered some element of double taxation on their business profits, either when entering into self assessment in the late 90’s or if they commenced in or joined a business thereafter.  Any carried overlap profits can be claimed in the transitional tax year 2022/23, which will help reduce assessable profits, but given that overlap profits are often created in the earlier years of trading when profits are generally lower, the benefit of this relief may not be significant.
  • Spreading relief – to the extent that an individual’s tax liability is higher in the transitional year than it would have otherwise been, the draft legislation proposes to allow this additional tax cost to be spread over a five-year period to ease concerns over cash flow.  This spreading relief is something we have seen before and, whilst the ability to spread the cost of any additional tax will be welcome, it will be important for anyone choosing this route to understand, in advance, how the additional tax can be funded in the future.

How can we help you?

At this point in time our message is that:

  • Sole trader and partnership businesses should be aware of HMRC’s consultation on basis period reform, which is open for feedback until 31 August 2021; however
  • The consultation is only at stage three of five and hence, following feedback from firms like Ryecroft Glenton and our representative professional bodies, HMRC’s proposals may change or be delayed.

We expect HMRC to respond to feedback generated during the consultation process relatively quickly and certainly by October, at which time we can help you to understand how you stand to be affected and whether any action should be taken to mitigate tax increases or to improve cash flow.

Business preparing their annual accounts to dates early in the tax year – for example April, May and June – are likely to be affected more significantly if HMRC’s proposals do go ahead, so please, if you fall into this category and have any immediate queries or concerns, do get in touch with our Agricultural and Landed Estates Teams for support.

Photo by Spencer Pugh on Unsplash

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