HMRC changes tax laws for sole traders and partnerships

According to data released by the government in October 2022, there were in existence some 5.5 million small businesses employing under 49 workers, 35,900 medium sized firms with 50 to 249 staff, and just 7700 with 250 or more employees.

Notably around 3.1 million were set up as sole traders and around 300,000 were run as partnerships. There were also some 2.1 million companies.

It’s these unincorporated businesses – sole traders or partnerships – who don’t already draw up their accounts up to 31 March or 5 April each year that HMRC is now targeting with a new taxation regime.

These businesses should give serious consideration to changing their accounting date to avoid tax complications in the future – and doing so very soon – because from 6 April (2023), how income tax payable by such businesses is calculated changed under new rules brought in by HMRC.

However, the tax body is worried that many businesses still seem to have not heeded its warnings about how it’ll impact their business. Put simply, some sole traders or partnerships could end up paying much more in tax and be burdened with extra unnecessary admin too.

The change to what is known as the ‘basis period’ rules will make little or no difference to the many businesses that already have a 5 April or 31 March year end. But as Emma Rawson, a technical officer at the ATT, points out, “for those with accounting years that do not align with the tax year, the impact will be significant.”

Unfortunately, she says that “many businesses who could be hit by this change remain unaware of it. The resulting temporary increase in their tax bills, and ongoing additional admin burdens, could therefore come as a nasty shock.” She adds that while there is little that can be done about the additional tax, “taking steps now to change your accounting date could help make your life easier in the long run.”

What’s changed

Currently, once established, sole traders and partnerships pay income tax on the profits of their accounting year ending in the tax year. For example, if a trader draws up accounts to 31 December each year, in the tax year 2022/23 they will be taxed on profits for the year ended 31 December 2022.

From April 2024, Rawson says that this all will change, and they will instead pay tax on the profits they actually earn in any one tax year – i.e. from 6 April to the following 5 April. 

She notes that “tax year 2023/24 is a ‘transitional year’, in which the tax system swaps over from the current basis to the new tax year basis. To achieve this, special rules apply to calculate taxable profits and tax. Effectively, those that have a year-end other than 31 March or 5 April, will be taxed on their normal basis period plus an extra amount of profits to bring them up to the end of the tax year.” Rawson gives the example of a business with a 31 December year end that will be taxed on their profits for the year ended 31 December 2023 plus their profits for the period from 1 January 2024 to 5 April 2024.

Rawson highlights that this will result in more than 12 months’ worth of profit being taxed in 2023/24. To help ease any additional tax arising as a result, she says that “businesses can offset any ‘overlap profits’ they may have from their early years of trading (when they may have been taxed twice due to how the old basis period rules work). They may also be able to spread any remaining ‘excess profits’ over up to five years.”

The problem outlined

As noted above, the transitional year rules could see a temporary increase in the tax payable by businesses without a 31 March or 5 April year-end. However, for Rawson that is not the end of the story as these businesses will also experience ongoing additional admin burdens.

In particular, she warns that once these changes come in, those that draw up accounts to something other than 31 March or 5 April, will have extra work to do each time they complete their tax return: “To get to the profits for a tax year, they will need to combine amounts from two separate sets of accounts and depending on how late the accounting date falls, the second set of accounts may not be ready by the time they come to file their tax return.”

By way of example, Rawson details that if the trader has a December year-end, to calculate the profits for the 2024/25 tax year they will need to take amounts from their accounts for both the year ended 31 December 2024 and the year ended 31 December 2025. However, as the deadline for filing the tax return for that year is 31 January 2026, Rawson thinks it highly unlikely that they’ll have the second set of accounts ready in time. 

Where this is the case, she says that “they will have to estimate the amount of profits to take from the second set of accounts and include a ‘provisional figure’ on the tax return. They will then need to amend the return to correct that provisional figure within one year of the original filing deadline – i.e. by 31 January 2027 for a 2024/25 return.”

Irritatingly, these extra steps are not a one-off but will recur every year when they prepare their tax return.

Making the change

So, with the change set out, Rawson says that the best way to avoid these ongoing administrative burdens is to change the accounting date to 31 March or 5 April. It’s that simple.

Luckily, for the moment, Rawson says that it’s possible to change the accounting date by drawing up a set of accounts for a shorter, or longer, period than usual, ending with the new accounting date. For example, if the trader normally has a 31 December accounting date, instead of drawing up accounts to 31 December 2023, they could draw them up for the 15-month period ending on 31 March 2024.

She says that the best time to make this change may be during the transitional year 2023/24. This is because “special rules applying in that tax year may allow them to ‘spread’ any excess profits they have to bring into account as a result over up to five years – something which isn’t available if they make the change in any other tax year.”

Beyond that, Rawson explains that “another advantage of changing in 2023/24 is that the normal rule, which says a set of accounts can’t be longer than 18 months, is disapplied in that year. This means that they can draw up one long set of accounts to make the change.” So, if the current year-end is 30 April, they could change this by drawing up a single 23-month set of accounts for the period from 1 May 2022 to 31 March 2024. 

Make the change?

Unfortunately, moving the accounting date will not help the trader escape any temporary increase in tax as a result of the change of the basis period rules. However, from Rawson’s standpoint, it will greatly reduce their ongoing admin burdens as they won’t have to worry about splitting accounting figures between tax years or estimating and then correcting provisional figures. This will clearly save time and effort and, says Rawson, “may also help avoid a significant increase in fees if they pay someone to prepare a self-assessment return.” And then there’s the issue that tax return fees are likely to increase for businesses with an accounting date other than 31 March or 5 April, as tax agents will have to do more work to calculate the profits for the year, as well as having to amend returns to correct any provisional figures used. 

So, in Rawson’s view, “changing an accounting date to 31 March or 5 April will undoubtedly make a trader’s life easier from a tax perspective.”

Summary

Of course, before making any business change, good advice is necessary to weigh up what’s best for the business overall alongside the tax-related issues. Time spent with an accountant or tax adviser in seeking more help and information would be a wise investment.

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