A new tax basis for business – it may be simpler but it should not be rushed

Robin Williamson discusses an important consultation published on L Day

“Legislation Day”, or “L Day”, is when the Government puts forward for consultation a series of proposals in the form of draft clauses that it intends to include in the Finance Bill later in the year. L Day this year was 20 July, when among other announcements the Government launched a consultation about reforming the basis period system for businesses, to replace it with a tax year basis.

In this article I shall outline the proposal, weighing advantages and disadvantages, then question whether six weeks is really long enough to consult on all the ramifications.

Outline of proposal: 2022/23 and 2023/34 onwards

In the run-up to Making Tax Digital for income tax, HMRC have proposed that instead of basing their profits or losses for tax purposes on a basis period of 12 months ending on the accounting date in the tax year, as now, businesses would instead be required to account for tax on the basis of the profits or losses accrued in the tax year. This change to the “tax year basis” would come into effect in 2023/24.

Businesses would not be required to change their accounting date to 31 March or 5 April, but if they use a different date, the profits or losses of two accounting periods would have to be apportioned to give the result for the tax year.

The year 2022/23 would be a transitional year during which those businesses that do not already have basis periods ending on 31 March or 5 April will be aligned to the tax year, and any outstanding overlap relief arising from overlapping basis periods at the start of trading will be given. During the transitional year, businesses would use the same basis period as now, plus a transition period beginning on the day following the normal accounting date and ending on 5 April.

Example 1

A business that makes up its accounts to 30 September would in 2022/23 be taxed on the profits for the 12 months ending on 30 September 2022, plus the period from 1 October 2022 up to 5 April 2023.

If profits for the transitional year exceed those for the 12 months ending on the accounting date in 2022/23, the excess would be spread over five tax years unless the trader elects for an additional amount to be charged to tax in any year.

Example 2

Say the business in example 1 has taxable profits of £20,000 in the accounting period to 30 September 2022 and £10,000 is apportionable to the transition period from 1 October 2022 to 5 April 2023. The transition period profits are £10,000 less any deduction for overlap relief. The resulting amount is spread over 2022/23 and the following four years as to 20% in each year and taxed accordingly, unless the business elects for a shorter spreading period or ceases trading in the meantime, in which case the balance of the transition period profits becomes chargeable in the final tax year of trading.

Businesses which commence or have an accounting date between 31 March and 5 April may treat profits or losses arising between that date and the tax year end as belonging to the following tax year, so that there is no need to apportion small amounts accruing for those few days.

Simplicity for most businesses

This proposal originated in HMRC’s call for evidence The tax administration framework: Supporting a 21st century tax system published on 23 March 2021. It is seen as simplifying tax for businesses (which term includes self-employed traders, including individuals with a vocation or profession, traders in partnerships, and other unincorporated entities with trading income, such as trading trusts and estates and non-resident companies with trading income charged to income tax). Of course, getting rid of the more complex basis period rules, particularly on early and closing years, overlap relief and change of accounting date, is an undoubted simplification for most.

The measure is also intended to promote fairness between businesses for whom different accounting dates mean that profits for a tax year can diverge widely under the current system. Other advantages are cited as bringing payment of tax closer to the time when profits are earned, and aligning reporting requirements for different types of income for the purposes of Making Tax Digital.

More complexity for some

In their impact assessment HMRC predict one-off costs for businesses in familiarising themselves with the changes and updating software.

For those with accounting dates that are not coterminous with the tax year, HMRC also predict ongoing costs in estimating and apportioning profits between the accounting date and tax year end, and amending returns after submission when the actual figures become established. HMRC estimate that 93% of sole traders and 67% of partners already draw up accounts to 31 March or 5 April, but the remainder will potentially have to provide such estimates; the CIOT in its press release on the announcement estimates that half a million unincorporated businesses have an accounting year end other than 31 March or 5 April. In the CIOT’s view the change will “effectively force these businesses to change their accounting date to 5 April or 31 March in order to avoid this additional complexity”. That could be problematic for those whose present choice of accounting date is driven by commercial, non-tax considerations, such as seasonal businesses or those with overseas connections.

Those businesses that will have to estimate their profits or losses from their accounting date to the tax year end will need to amend their returns when final figures are available, and that will extend the enquiry window as far as the quarter day following twelve months from the date of filing the amendment. Depending on the availability of overlap relief to be deducted from the transition profit, their tax bill for 2022/23 might well be larger than it would have been under the current system, and they will have to plan their cash flow accordingly.

No doubt other snags will become apparent as the detail of the proposals is worked through. One obvious point is that long-established businesses may no longer have records of any overlap relief that may have accrued many years previously.

Length of consultation period

Responses to the consultation on this important change are requested by 31 August 2021.

Ever since Making Tax Digital was first mooted, it has been plain that some adjustment of the system of taxing the self-employed and other businesses would have to be made to facilitate quarterly reporting. Yet only now is a detailed reform of the whole basis of taxation being announced with a six-week consultation period in the middle of summer and during a pandemic. Compare and contrast the very extensive and careful consultations on the introduction of self-assessment in the early 1990s, with the legislation itself being introduced gradually over two years and entering into force in year three. Other comparable consultation exercises have proceeded in two stages – first, the proposals; then a second stage informed by the result of the first consultation and providing the draft legislation.

No doubt the Budget arithmetic has already been done on the assumption that Making Tax Digital for income tax will be in force in 2023/24 – hence the unseemly rush to conclude this consultation. Although the policy proposals are straightforward, the detailed implementation could (as so often) cause disruption and delay, and mistakes made now will only have to be patched up and corrected after the provisions have come into force. There seems no reason for this important consultation not to comply with the Government’s Code of Practice on consultations which recommends a minimum period of 12 weeks or longer if appropriate. There may also be a strong case for delaying the start of Making Tax Digital for income tax by at least a year to allow time for software development and to give businesses that might be adversely affected a chance to adjust.

Practitioners whose clients this change will affect should participate fully in the consultation and might well start by pointing out the desirability of giving it more time.

Robin Williamson MBE CTA (Fellow) is an author and commentator on tax, welfare and public policy. He was technical director of the CIOT’s Low Incomes Tax Reform Group from 2003 to 2018 and a part-time senior policy adviser at the Office of Tax Simplification from 2018 to 2019. In May 2020 he won the lifetime achievement award at the Tolley Taxation Awards. He was recently appointed UK country reporter to the Observatory on the Protection of Taxpayer Rights at the IBFD.

Robin Williamson

Written by Robin Williamson

Robin Williamson MBE CTA (Fellow) is an author and commentator on tax, welfare and public policy. He was technical director of the CIOT’s Low Incomes Tax Reform Group from 2003 to 2018 and a part-time senior policy adviser at the Office of Tax Simplification from 2018 to 2019. In May 2020 he won the lifetime achievement award at the Tolley Taxation Awards. He was recently appointed UK country reporter to the Observatory on the Protection of Taxpayer Rights at the IBFD.

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