Making Tax Digital for Income Tax (MTD ITSA) is due to start on 6 April 2024 with the first year being 2024/25. In preparation, the rules that determine which profits of a non-company business are charged to tax for a particular tax year are also being reformed.
Which businesses will be affected?
It is important to note that not all unincorporated businesses will be affected. Basis period reform will only affect those businesses that do not have a 31 March – 5 April accounting year-end. Though MTD ITSA does not include partnerships initially, basis period reform affects all unincorporated clients without 31 March – 5 April year ends, sole traders, and partnerships alike.
What is changing?
The existing rules, which tax profits of an unincorporated business on a current year basis, are being abolished. Instead, profits will be taxed on a tax year basis. Therefore, a tax return will show results for the tax year (6 April to 5 April) whatever the actual accounting date. An accounting date anywhere between 31 March and 5 April will be treated as being coterminous with a tax year.
Transition from one method to another
The 2023/24 tax year will be a transitional year to enable the change. For this year only, all businesses will be required to complete a tax return showing results for a period from the end of the basis period in 2022/23 to 5 April 2024. This change means that any business that does not prepare accounts on a tax year basis (6 April to 5 April) will declare and be taxed on profits of more than 12 months. The practicalities are that where the accounting date falls early in the tax year, the number of additional months to bring into account will be more than where the accounting date is later in the tax year.
For example, where a business prepares its accounts to 30 June each year, for 2023/24, the basis period will run from 1 July 2022 to 5 April 2024, i.e. 21 months. The tax bill will be based on results from the year to 30 June 2022 plus 9/12ths of results from the year to 30 June 2024. Businesses with an accounting date of 30 April will potentially be worse hit reporting nearly two years’ profits on one tax return for 2023/24. The basis period will run from 1 May 2022 to 5 April 2024 i.e. 23 months which means reporting the year to 30 May 2023 plus 11 /12ths of the year to 30 May 2024.
Importantly this change will also mean a shift in timing of the tax payment, which will be due nine months after the accounting year end instead of 21 months. Any relief for overlap profits will be given in the transitional year only.
Do you have to change your year-end?
Businesses are not being forced to change their accounting period to align with the tax year as it is only the method of reporting that is changing. However, many may find it easier and less complex to do so not least because otherwise the profit or loss will be apportioned from two sets of accounts into two tax years on a pro-rata basis.
Will the change result in a higher tax bill?
Declaring more than 12 months on one tax return may result in a higher tax bill (even potentially being taxed at higher tax rates) in 2023/24. However, to prevent this happening the ‘transition component’ will not be taxed in full in 2023/24. This ‘component’ comprises the profit attributable to the period running from the date of the last years’ accounts in 2022 to 5 April 2023 (the end of the 2022/23 tax year). Instead, the additional amount will be automatically spread over five years starting with 2023/24. The business can elect for spreading not to apply if it would be more tax efficient to be taxed in full in 2023/24. This will usually be the case where losses are available or if the personal allowance may otherwise be wasted. However, no spreading relief will be available should a business change its accounting date to align with the tax year before 5 April 2023. Any unrelieved relief for overlap profits can also be utilised.
Should you act now?
Any unincorporated business that does not already have a 31 March or 5 April year-end should consider the implication of the reform possibly by changing year ends before 5 April 2023 ahead of the transition year, or even incorporating.