Reforms to the tax system that will make it easier for small businesses to fill out their returns so that profits will be taxed in the year they are earned have been announced by the government. However, there is the opportunity for small businesses to have their say (see foot of this article for the link), so please do let the government know your thoughts!
The changes, which will come into force by 2023 and have been drawn up alongside representatives of small businesses, will mean businesses will be taxed on profits arising in a tax year, rather than profits of accounts ending in the tax year. It should help them spend less time filing their taxes - aligning the way self-employed profits are taxed with other forms of income, such as property and investment income.
The rule change affects the self-employed, partnerships, trusts, and estates with trading income.
This proposal changes the current reporting to a ‘tax year basis’ with effect from 2023 to 2024, so that a business’s profit or loss for a tax year is the profit or loss arising in the tax year itself, regardless of its accounting date. This removes the basis period rules and prevents the creation of further overlap relief.
On transition to the proposed tax year basis in the tax year 2022 to 2023, all businesses’ basis periods would be aligned to the tax year and all outstanding overlap relief given.
For businesses with higher profits in 2022 to 2023 due to the change in basis, the government is considering an election to spread the additional profits over a period of up to five years. Details will be finalised following consultation.
All other forms of income are taxed on a tax year basis for individuals, including property income, interest and dividends so the change would align small business tax with these.
‘A transition to the tax year basis would have no impact for the estimated 93% of sole traders and 67% of partnerships that draw up accounts to 5 April or 31 March,’ the HMRC consultation stated. ‘For businesses that have basis periods ending on dates other than 5 April or 31 March, the move to the tax year basis would potentially bring forward tax liabilities.’
HMRC will have to make changes to its IT systems to support timely delivery of this policy. There is also likely to be impact on HMRC contact centres in supporting taxpayers adjust to this change. Costs are anticipated to be between £15m and £20m to deliver this change.
Financial secretary to the Treasury Jesse Norman said: ‘These complex rules lead to thousands of errors and mistakes in self-employed tax returns every year.
‘Simplifying them will allow self-employed people to spend less time doing tax admin and more time growing their business and creating jobs.’
Under the current system, tax returns filed by the self-employed, sole traders and partnerships are based on a business’s set of accounts ending in the tax year (5 April). More complex rules apply when a business starts and draws up its accounts to a date different to the end of the tax year.
In those cases, taxpayers pay tax for their first tax year on the period to the end of the tax year, and then in subsequent years on the basis of their full accounting year, meaning profits are taxed twice and complex rules apply to relieve the double taxation when the business finishes.
These rules can be confusing to understand, particularly for new businesses, leading to thousands of errors and mistakes in tax returns. More than half of those affected do not claim relief they are entitled to and could pay tax twice.
Overlap relief is normally given when a business changes its accounting date or stops trading, if two of its basis periods have overlapped in the past. The current system is more complex for some businesses, as the time period of their accounts is different to the tax year. The reform will mean businesses pay tax on profits in the tax year they actually occur.
This proposal was put forward as an example of a possible simplification in ‘The tax administration framework: Supporting a 21st century tax system’ call for evidence published on 23 March 2021.
The change aligns with the government’s plans to provide self-employed business owners with a more modern, digital, integrated service through the implementation of Making Tax Digital (MTD) for Income Tax. This will help reduce errors and ensure self-employed businesses get their tax right first time.
The change to the time periods against which businesses report their tax will also reduce the number of times those with several sources of income will need to report their income under MTD for Income Tax.
The government is consulting on the changes to taxation for small business and the consultation period is open for comment until 31 August 2021. You can have your say here.
Stewart McKinnon, Director, M&S Accountancy & Taxation