How does the tax system currently work?
The UK’s tax year ends on 5 April and while many businesses choose 31 March as a year end to broadly tie in with that date, many other businesses choose a different accounting year end date for commercial reasons, for example 31 December.
When an individual starts to trade or joins a partnership and the year end for the business is not aligned with the tax year, some profits are taxed twice – in the first and second tax years of trading. These profits are ‘overlap profits’. Thereafter, an individual is subject to tax on 12 months of profits based on the business’s accounting year end ending in the tax year.
The overlap profits are carried forward and set against future profits in certain circumstances, such as leaving the business, the business ceasing or a change in the accounting year.
What is HMRC’s proposal?
The proposal is to remove the existing basis period rules and change to a ‘tax year basis’. This would mean the profit or loss for the business is the profit or loss arising in the tax year, regardless of the accounting date. Where a business has a year end other than 31 March (which is accepted as being 5 April for these purposes), profits will be apportioned between tax years.
This will prevent overlap profits from accruing in the future and will result in offset of any unused overlap profits for those in business when the change is made. Those affected by the proposal include sole traders, partners in partnerships, members of LLPs and other unincorporated entities with trading income, such as trading trusts and estates.
When would this take place?
The transition will occur in the 2022/23 tax year, which begins on 6 April 2022:
1. For 2022/23, businesses that do not have an accounting year end date aligned to the tax year would be brought into line with the tax year basis with overlap profits being offset.
2. For 2023/24 and future years, all individuals and businesses will be on a tax year basis. This will coincide neatly for HMRC as Income Tax moves across to Making Tax Digital from 6 April 2023.