Reforms to the way profits of unincorporated businesses will be taxed are going ahead as expected. This is in line with the government’s aim to complete the roll out of Making Tax Digital (MTD), for Income Tax by 2024/25.
As anticipated, these changes will affect unincorporated businesses that do not use a 31 March or 5 April accounting year end. The changes will take full effect from 2024/2025, with 2023/2024 being a transitional year.
The reforms mean that the basis period for an unincorporated business will change from a ‘current year basis’ to a ‘tax year basis'. This means that such businesses will be taxed on profits made during a tax year, rather than over an accounting period, irrespective of the accounting year end of the business. In the year of change, businesses who do not have a year end of 31 March will be taxed on the profits for an extended period, less any overlap profits brought forward.
Whilst there is no requirement to change the accounting period of a business, the way in which profits will be taxed on a tax year basis may mean it would be simpler for affected taxpayers to review their accounting year ends before the changes come into effect.
Impact
A worked example may be best to demonstrate how this works. Under the current rules, if a business has a normal accounting year end of 30 September, in 2022/23 the individual will be taxed solely upon the profits for the year ended 30 September 2022.
In the following year, under the new rules, the individual will not only be taxed on the profits for the year ended 30 September 2023, but also the profits for the period from 1 October 2023 to 31 March 2024. Any overlap profits brought forward from when the business commenced, or from when the accounting period changed, can be utilised:
| 2023/24 | ||
| Year ended 30 September 2023 | 100,000 | |
| Period 1 October 2023 to 31 March 2024 | 50,000 | |
| Total | 150,000 | |
| Less overlap profit brought forward | (20,000) | |
| Taxable profit | 130,000 | |
The example above shows that even where overlap profits are deducted, for affected taxpayers there is likely to be an impact on cash flow, when implementing the new rules. The government has announced that the additional profits which become taxable because of this change can be taxed over the 5 years from 2023/24 to 2027/28, to ease this position. If it is the case that the taxpayer has higher overlap profits, meaning that relief may be greater than the extra profits being taxed, it will be possible to elect to disapply the 5-year spreading of tax payable.
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