Proposed reform to basis periods for Income Tax for the self-employed
HMRC has recently published draft legislation and an accompanying policy paper proposing changes aimed at simplifying Income Tax rules for the self-employed by amending the way trading income is allocated to tax years. A consultation has also been published seeking views on how best to implement the proposed new rules.
The new rules will align trading income with other forms of taxable income such as dividends, interest and property income, and will mainly affect those whose accounting period end date is not 31 March or 5 April.
Currently, the self-employed are taxed on their profit or loss for the 12-month period ending with their accounting date which falls within the tax year. This is the ‘basis period’ and this system uses the ‘current year basis’. Whilst many will align their basis period with the tax year, others may decide, for commercial or strategic reasons, to choose a different accounting date.
There are specific rules that determine the basis period in certain instances, including during the early years of trading. This can result in the those newly self-employed having a different accounting period to the tax year.
These rules can create ‘overlapping’ basis periods, meaning that tax can be charged on profits twice. Where this happens, the self-employed can claim ‘overlap relief’ when their business ceases. However, the current system is complex and can lead to mistakes being made.
What are the proposed changes?
The proposed changes are due to take effect from 2023 to 2024 and will amend the basis period for all self-employed business owners to the end of the tax year. This is the ‘tax year basis’. This will mean a self-employed business’ taxable profits or allowable losses would arise in the tax year itself, regardless of its accounting end date.
The new rules will mean that for those self-employed business owners who have a different accounting end period to that of the tax year, they will need to apportion the profit or loss arising in a specific tax year.
By using the ‘tax year basis’, under the new rules, overlapping basis periods would be removed, meaning that profits would no longer be taxed twice and there would be no new overlap profits generated.
There will be a transition year in 2022 to 2023 where the basis period will be aligned to the tax year and any outstanding overlap profit relief will be given in full and not carried forward into the tax year basis.
The Government is considering allowing those with higher profits in 2022 to 2023, because of the basis changes, to choose to spread the additional profits over a period of up to 5 years.
If introduced, the proposed changes to the basis period would be in place before Making Tax Digital for Income Tax is implemented.
Having your say
The Government has opened a consultation for those affected by the proposals, such as the self-employed, partnerships, trusts and estates with trading income, and are seeking views on how best to implement the proposed changes.
This consultation ends on 31 August 2021 and details can be found in the following link: https://www.gov.uk/government/consultations/basis-period-reform/basis-period-reform-consultation
In the short-term, the new proposals may have an adverse effect on some self-employed business owners as the changes will undoubtably require new administrative procedures, resources and costs to address the new tax rules.
Whilst these changes are currently only proposals, it is likely that they will be introduced as planned and therefore businesses that are impacted by these new rules should start to prepare early for their introduction.
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