The government has announced plans to change how small businesses report their profits for tax purposes.
The intention is for profits from unincorporated businesses to be reported and taxed in the tax year in which they are earned. The rule change will affect the self-employed, partnerships, trusts, and estates with trading income.
It is proposed that the "tax year" basis will apply fully from 2023/24. Profits will be taxed in the tax year in which they are generated, regardless of the accounting date used by the business. The current "basis period" rules, which (broadly) tax profits of the accounting year that ends in the relevant tax year, will end.
On transition to the new tax year basis in the tax year 2022/23, it is suggested that all businesses' basis periods will be aligned with the tax year and any outstanding overlap relief will be given.
For businesses with higher taxable profits in 2022/23 due to the change in basis, the government is considering an election to spread the additional profits over a period of up to five years. Details will be finalised following a period of consultation.
All other forms of income are already taxed on a tax year basis for individuals, so this change will bring the small business tax periods into alignment.
HMRC has suggested that 93% of sole traders and 67% of partnerships already draw up accounts to 31 March or 5 April, so a minority of businesses will be affected.
However, the transitional arrangements are likely to accelerate tax liabilities for many businesses that don't currently draw up accounts to 31 March or 5 April, so we await further announcements about the proposed transitional "spreading" election with interest.
The proposed approach would seem to incentivise businesses who do not currently draw up accounts to 31 March or 5 April to consider changing their accounting periods. However, there are often sound commercial and (under the existing framework) tax reasons for choosing a different accounting date.
If you may be affected by these proposals, get in touch with us to discuss options.