The changes
HMRC have introduced changes to the way that the self employed are taxed by amending the time period in which taxable profits are calculated.
Previously sole traders and partnerships have been able to manage their accounts and report their profits based on their accounting year. From April 2024, unincorporated businesses will move to the tax year basis, meaning that they will need to report on profits generated in the tax year as opposed to their previously chosen accounting period. No change is required for those businesses that already use the financial year ending 31 March or 5 April.
There may be higher profits charged to tax
The tax year 2023/24 is a transitional year which aligns the profits in accounting periods with the tax year for accounting periods which do not end on 31 March or 5 April.
The taxable profits for 2023/24 will be those from the end of the period assessed in 2022/23 to 5 April 2024. For a 30 April year end for example this would be 23 months of profits (from 1 May 2022 – 5 April 2024).
The change could mean higher amounts of profits being charged to tax not only in the tax year 2023/24 but also in the following four tax years as the rules spread the adjustment over five years.
Overlap relief
Under the old rules for allocating profits to tax years there were situations when businesses first started trading where profits were taxed twice. This happened when the accounting year end was not 31 March or 5 April. In some cases, traders chose to have 30 April year ends to maximise the time between earning profits and paying the tax on those profits.
Where profits were taxed twice the amount was known as overlap profit and the old rules allowed a deduction for these profits when the business ceased or when the business changed the accounting year end.
Under the reforms to the tax rules these overlap profits will be allowed as a relief against the additional transition profits in the tax year 2023/24.
There will be a deduction for overlap profits which arose in the early years of the business but if the business has grown these are likely to be much smaller than the extra profits coming into the calculation.
The extra profits less any overlap relief can be spread over five years starting in 2023/24 as long as the business does not cease, or the partner does not retire or leave the partnership.
There may be some possibility to mitigate any overall increase in profits arising in 2023/24 and we would be happy to discuss these with you.
Impact of higher profits
As noted above there could be higher levels of profits being taxed for 2023/24 through to 2027/28. This could impact on the following areas:
- tapering of an individual’s personal allowance
- the cap on income tax reliefs
- savings nil rate band
- limits on pension contributions
- higher NICs for these years
We would be happy to discuss these further and calculate what the possible impact could be for you.
Does a business have to change its accounting year end to match the tax year?
No, a business can maintain an accounting year which does not match the tax year but for the purposes of completing the tax return, the business will need to apportion profits or losses to tax years.
Where an accounting period ends later in the tax year, eg 31 December the accounting period may not have ended when the apportionment is being done and so an estimation of the profits or losses would need to be calculated with a revised return being submitted once final figures are known. This could add to the costs of preparing your tax return.
Businesses that have a 31 March year end will be treated as having an accounting period that matches the tax year and many businesses will choose to change their year end to 31 March on 31 March 2024.
We are happy to discuss with you
If you are a sole trader or partner in a partnership and think that these changes in rules may affect you, please get in touch so we can review your tax position and discuss the options open to you.
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