Impact for sole traders and partnerships of changing to tax-year basis
Helen Fraser, Tax Advisory Manager

In preparation for the introduction of Making Tax Digital (MTD) for Income Tax in April 2023 for sole traders and partnerships, the government is considering a change to how sole traders and partnerships are taxed, whereby everyone will be taxed to 5 April, instead of the current year basis we currently have in place, which depends on the year-end you have.

We’ll take a look at how the proposed changes will impact on those unincorporated businesses who don’t currently prepare their accounts to a date of either 31 March or 5 April.

Why change to the tax year basis?

Given that the introduction of MTD for Income Tax is now less than two years away for self-employed or landlords with a business or property income over £10,000, it seems to be certain that a change to how these businesses will be taxed will be implemented, to be ready for April 2023.  However, this was only recently announced by the government and hasn’t yet been changed in law, so no fixed timelines are confirmed.

How could the proposed changes work?

The changes will likely be phased-in in 2022/23 and be fully implemented by 2023/24.  However, there will be an impact that could see tax liabilities change or even accelerate for some individuals.

Considerations

There’s a few things to consider if a change to the the tax-year basis is changed in law, including:

  • How the tax will be dealt within the individual partner or sole trader’s tax return in the transition period (2022/23), taking into account any overlap profits.
  • If applying for a mortgage during this transition period, an explanation would likely be required.
  • For tax year 2023/24 and beyond, it will still be possible to prepare accounts to a different year-end, however, profits will still be apportioned to the tax year when looking at the tax return, so it may be easier to change the year-end formally.

Illustrative example for looking at taxable profits

Say a sole trader has the following taxable profits with £15,000 of overlap profits brought forward:

  • £42,000 for the year ended 31 July 2022
  • £51,000 for the year ended 31 July 2023

If the rules don’t change, the sole trader’s tax return for 2022/23 will report £42,000 of taxable profits.

If the rules change, the 2022/23 return will instead report the following profits:

£42,000 Profits for year ended 31 July 2022
£34,000 £51,000 x (8/12) – profits in transition period (1 August 2022 – 5 April 2023)
£15,000 Less overlap relief
£19,000 Excess amount (£34,000 less £15,000)
£61,000 Taxable profits before spreading election for 2022/23

If you choose to spread the excess amount, this can be over a period of up to 5 years:

£19,000 / 5 years = £3,800 per year.

Therefore the sole trader’s tax return will include income of £45,800:

  • £42,000 – profits for year ended 31 July 2022
  • £3,800 – excess amount of £19,000 / 5

The tax years ended 2023/24 to 2026/27 would all include £3,800 on top of the profits for the year ended 5 April each year.

Next steps

If you don’t currently work to an accounting year-end of 31 March or 5 April, we would suggest that you start planning now to make the transition.

We will, of course, keep you updated and let you know as soon as any change of date is confirmed.  If you do have any questions or would like help or further advice, please do contact us – we’re here to support you.

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