Income tax basis period reform and earlier payment of tax

Fundamental change to way individuals’ trading income (including partnerships) will be taxed that may apply to current accounting periods.

Fundamental change to way individuals’ trading income (including partnerships) will be...

As the Government moves rapidly towards introducing Making Tax Digital for Income Tax which will require quarterly reporting from April 2023, HMRC have published a policy paper, draft legislation and a consultation setting out fundamental changes to the rules for taxing trading income (including income from a profession or vocation). This will impact individuals, trusts, partnerships and others with trading income that is subject to Income Tax. The proposals change the basis period from a ‘current year basis’ to a ‘tax year basis’. This will change the underlying profits or losses subject to tax from the 2022/23 tax year onwards and bring forward the time at which tax on such profit is due for payment. These proposals are subject to consultation but given that they may apply to current accounting periods, taxpayers should ensure they understand the impact of these new rules on their business and make informed decisions.

Proposal

A business’s profit or loss for a tax year would be the profit or loss that occurs in the actual tax year itself, regardless of its accounting date.

Who will be affected?

The proposed changes will impact individuals, trusts and partnerships with trading income (including income from a profession or vocation) as well as unincorporated entities with trading income, such as trading trusts and estates and non-resident companies with trading income charged to Income Tax.

Timing

The changes would come into effect from 2023/24 to ‘simplify’ the rules before the introduction of Making Tax Digital for Income Tax.

Proposed transition would take place in 2022/23.

What is the impact?

The proposals will bring forward the timing of tax payments.

For those with an accounting date other than 5 April (or 31 March) there will be an apportionment of profits to determine the profits treated as arising in the tax year.

For businesses that reach the filing deadline for a tax year without having drawn up accounts covering the entirety of the tax year, estimated results will be needed from which to make apportionments.

The transition year

A one-year transition period is proposed with two components determining the basis of taxable profits for the 2022/23 tax year.

For example, the basis period for a business with a 30 June year end would be determined by adding together two components:

  • Taxable profit for the year ended 30 June 2022 - the standard component; plus
  • Taxable profit from 1 July 2022 to 5 April 2023 - the transition component.

Overlap profits from the early years of trade must be deducted from the profits of the transitional year.

For businesses where profits in the transition tax year are higher than if calculated under the current basis of assessment, because of the changes to basis periods, the Government proposes an election to spread any ‘excess profits’ in the transition year over up to five years.

What actions can affected taxpayers consider? 

With fundamental changes to the basis period for charging tax and acceleration of the timing of the payment of tax on profits, taxpayers should consider taking expert specialist advice to help ensure they:

  • Understand the real impact of these changes on their business;
  • Have accurate timely information on which to make informed decisions and appropriate plans; and
  • Manage cashflow.