If you are self-employed, or work together with others in partnership, you may be affected by new rules coming into effect from 6 April 2023.

These rules will not affect you if your accounting year end is either 31 March or 1 – 5 April, as such year ends are all treated as if they were 5 April.

Everyone else will be affected by the change.

In the past you have been able to select whatever accounts year end you liked for tax purposes. The tax system treated the profits for your accounts year ended in the tax year as the income of the tax year. This had its own complications with what are called basis periods.  Going forward, the Government has decided to remove that complication – and create a whole new set – by taxing unincorporated businesses (so the self-employed and partnerships) on the profits of the tax year. The new system will apply from 2024/25, but to prepare for it a transitional system will apply for 2023/24.

This creates a bit of a headache for two reasons:

1. If you decide not to change your accounting date, you still have to show on your tax return your profits to either 31 March or 5 April. This means that you will have to apportion profits from two accounting periods.  For example, let’s say your year end is 31 December.  For the tax year 2024/25 your taxable profits will be 270/366 of your profits for the year to 31 December 2024 and 95/365 of your profits for the year to 31 December 2025.  If this wasn’t tricky enough, your tax return for the 2024/25 tax year is due on 31 January 2026 i.e. only 31 days after the end of your 31 December 2025 accounting year end.  You are unlikely to be able to produce those accounts in that short time. That means that you will need to estimate the profits (with possible penalties for underestimation) to complete your tax return in time, and file an amended tax return when your accounts are prepared and the correct figure is known.

2. The transitional rules for 2023/24 are far from simple. The concept is that over the life of your business you should pay tax on the actual profits earned. To achieve this, in the early years you pay tax twice on the profits from commencement to the end of the first tax year, but when the business ceases you are taxed in the final year on the profits since your last taxed year (which will be larger than the profits you actually earn in that year) but can deduct the amount on which you were previously taxed twice (called overlap relief). Sounds fair? Yes, but if your business has grown, the extra taxable amount in the final year will be much higher than the offset of overlap relief, potentially leaving you with a heavy unexpected tax bill.

The transitional rules tax you as if you had ceased business on 5 April 2024. So, with a 31 December year end, you will be taxable on the profits earned from I January 2023 to 5 April 2025, a period of 15 months, but can deduct your overlap relief. If you have a 30 April year end you will be taxable in 2023/24 on 23 months’ profit less the overlap relief (which will be 11 months of your first year’s profit).  However, the government accepted that is not reasonable, so you can spread part of the additional profits over five years.  The way this works is a bit complex. You cannot spread the profits of the first 12 months from your previous accounts date (called the standard period). The remainder of the taxable amount, less the overlap relief (the transitional amount) can be spread. The way this works is that for 2023/24 you are taxed on the profit of the standard period plus 20% of the transitional amount. For 2024/25 you are taxed on the actual profits of 2024/25 plus a further 20% of the transitional amount, and so on until 2027/28.

2024/25 you are taxed on the actual profits of 2024/25 plus a further 20% of the transitional amount, and so on until 2027/28.

Again, an example may be helpful.

Let’s say your year end is 31 December.  Your profits for 2023/24 will be worked out as follows:

• Your profits for the 12 months to 31 December 2023 (the standard period); plus
• Your profits for the period 1 January 2024 to 5 April 2024, less the overlap relief (the transitional amount).

On the assumption that you are profitable in both periods, the transitional amount can be  spread over five years beginning with the 2023/24 tax year.

The problem is that you can end up paying more tax than if the system had not changed.  This is because the transitional amount increases your taxable profits so that your total income for a tax year might move you into a different tax band.  This is especially harsh for those that have profits that fall within the personal allowance, who then find that their augmented profits push them over, as they would not expect to pay tax at all.

To ease the pain a little, you can however elect for more than 20% of the transitional amount to be taxed in any of the years affected. The balance of the transitional amount is then spread evenly over the remainder of the transition period. For example, suppose that for 2023/24 your standard period profits are £30,000 and the transitional amount is £20,000. You will be taxable in 2023/24 0n £30,000 plus 20% of £20,000 = £34,000. Suppose also that your other income equals your personal allowance, so you are taxable on that £34,000.  If you expect next year’s profits to be higher, you might elect for a further £3,700 of the transitional amount to be taxed in 2023/24 so as to utilize the balance of your 20% tax rate band.

What next?

Clearly these changes are going to cause complications for many businesses; and we haven’t even mentioned the extra complications where there are losses. So what should you do? If you wish to discuss this in more detail, please contact CBW Tax Consultant, Reshma Johar, or contact us at info@cbw.co.uk.