Unincorporated businesses, such as sole traders and partnerships, are facing significant changes in their income tax reporting obligations. The new rules, implemented by HMRC in April 2023, have raised concerns as many businesses appear to be unaware of the potential impact. This blog post aims to provide an overview of the changes and the implications for unincorporated businesses, emphasising the need for proactive measures to avoid unnecessary administrative burdens and increased tax payments.
1. The Change in Basis Period Rules:
Under the previous system, sole traders and partnerships paid income tax based on the profits of their accounting year that ended within the tax year. However, starting from April 2024, income tax will be calculated on the profits earned during a particular tax year rather than the accounting year. This shift will affect businesses with year-ends that do not align with March 31 or April 5.
2. Transitional Year and Additional Tax Burdens:
The tax year 2023/24 serves as a transitional year during which the change in basis period rules takes effect. Unincorporated businesses with year-ends differing from March 31 or April 5 will experience temporary increases in their tax bills. These businesses will be required to calculate taxable profits and tax by combining amounts from two separate sets of accounts.
3. Taxable Profits Calculation:
To align with the tax year, unincorporated businesses with non-conforming year-ends will be taxed on their normal basis period’s profits, plus an additional amount of profits covering the end of the accounting period to April 5. For example, a business with a year-end of December 31 will be taxed on the profits from January 1, 2024, to April 5, 2024, in addition to the profits for the year ended December 31, 2023.
4. Mitigating Additional Tax:
Unincorporated businesses can offset any “overlap profits” resulting from being taxed twice due to the previous basis period rules during the early years of trading. Moreover, they may be able to spread any remaining “excess profits” resulting from the transitional year over a period of up to five tax years. These measures aim to help alleviate the financial impact of the change.
5. Ongoing Administrative Burdens:
Apart from the temporary increase in tax, unincorporated businesses with non-conforming year-ends will also face additional administrative burdens. When filing tax returns, they will need to combine amounts from two sets of accounts and estimate the profits from the second set, which may not be available by the filing deadline. They must then amend the return within one year to correct the provisional figure.
7. Changing the Accounting Date:
To mitigate ongoing administrative challenges, businesses are advised to consider changing their accounting date to align with March 31 or April 5. This change can be made by preparing a set of accounts for a shorter or longer period, ending with the new accounting date. The transitional year, 2023/24, presents an opportune time for such a change due to special rules that allow the spreading of excess profits over five tax years and the relaxation of the 18-month accounts rule.
Unincorporated businesses need to be aware of the changes in income tax reporting rules, particularly the shift in basis period calculations. It is crucial to assess the impact on tax payments and additional administrative burdens. Taking proactive steps, such as changing the accounting date to align with March 31 or April 5, can help mitigate ongoing challenges and streamline tax reporting. By staying informed and seeking professional advice, businesses can navigate these changes effectively and ensure compliance while minimising unnecessary administrative burdens and potential financial implications.