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The Self Employed - Change of Basis Period 2022/23

The Self Employed - Change of Basis Period 2022/23
The Present Position
·       For a particular tax year, the S/e are normally taxed on the net profit per the accounts which end in that tax year. This is called the basis period.
 
Example of the Present Position
·       Tom has been S/e for a number of years and draws up accounts to 30th April each year. 
·       His accounts to 30th April 2021 shows net profit of £30,000. That is taxable in the 2021/22 tax year.
  The Proposed Change
·       The basis period will be aligned to the tax year.
·       The S/e will have to report and pay tax on the income and expenditure that arises precisely in the tax year. For this purpose, the tax year is deemed to be between 31st March and 5th April inclusive.
·       Losses will need to be reported in the same way.
·       The S/e business does not need to change its accounting year end to coincide with the tax year, but apportionment will be required if it does not do so. 
 
When is this likely to happen?
·       The first year is likely to be the 2022/23 tax year. This will be known as the transitional year.
 
What will happen in the transitional year?
·       Irrespective of the accounting period you choose, the profits /losses will have to be aligned to the 2022/23 tax year.
·       Overlap relief (profit), or transitional relief, if the business commenced pre 1996/97, can be brought forward to set off against the net profits calculated for 2022/23.
·       20% of any excess profit which arises as a result of this change will be taxed in 2022/23. The remaining excess is spread equally over the following 4 tax years.
·       If the S/e ceases prior to the end of that four year period, the residue excess profit is taxed in the final year of cessation.  
·       It may be possible to elect to bring forward the excess taxable in a later tax year into an earlier year.
 
 What is overlap relief (profit)?
·       It usually arises when the S/e commence trading but it can also occur if you have changed the accounting year end, at a later date in time, other than to a tax year end. 
·       Overlap relief arises from profit which has been taxed twice. Normally due to the commencement year rules, where some profit may be taxed twice in tax year 1 and 2.
·       In this case, the overlap relief (profit) can be brought forward to reduce the profit figure in the transitional year.  
 
Example of how the transitional rules may work
·       Mary has been S/e for many years and draws up accounts to 30th April
·       Her profits for the accounts year ended 30th April 2022 are £70,000
·       Her profits for the accounts year ended 30th April 2023 are £80,000
·       Mary’s overlap relief brought forward is £15,000.
·       The profits for the 2022/23 tax year are as follows;
a)     Accounts year ended 30th April 2022 £70,000 plus
b)     Transitional element – 1st May 2022 to 5 April 2023 – £80,000 x 11/12 = £73,333 less
c)     Overlap relief (£!5,000)
d)     Total profits for 2022/23 £128,333
e)     The profits exceeding the historical basis period is (£128,333 - £70,000) =  £58,333
f)      The excess profit - 20% spread equally over 5 tax years = £11,666 each year.
g)     The minimum taxable in 2022/23 is £70,000 + £11,666) = £81,666.
h)     Mary could elect to bring forward some of the transitional profits into the 2022/23 tax year 
 
Why might you consider making that election?
·       The tax and NI rates for a later year maybe higher.
·       They may find the 20% in a later year takes them into higher tax rates or affects their personal allowances or Child benefit claim.
·       It might enable them to enhance their pension provision by increasing their net relevant earnings for a particular year.
 
Why is the change being introduced?
·       Making Tax Digital for Income Tax (MTD ITSA) is arriving for the vast majority of S/e from April 2023. 
·       The Government want to align quarterly reporting dates for all S/e with the tax year, partly on the basis of administrative ease for them and partly because it will make it easier for the S/e to align their tax payments to the profits they are earning. 
 
Things to be considered
·       Should one consider changing the accounting year end to align with the tax year?
·       Is now the time to ensure that you have the overlap relief (profit) or transitional relief figures to hand in readiness for 2022/23?
·       Do you need to make potentially affected unincorporated business clients and prospects aware of the likely forthcoming changes?
·       Should you flag up the fact that, for some of them, there is likely to be a significant and unexpected increase in their tax bill, as a result of the change, in January and July 2024.
·       Partly as a result of this change, it is going to create a significant bunching of work for you to meet the MTD ITSA quarterly filing deadlines plus of course the SA filing date of 31st January. Are you ready for this?
·       Is it worth bringing the VAT MTD filing dates in line or is better to spread the workload out?
·       Is the client ready for MTD ITSA?
 
If I sell my garden will I end up paying tax?
Watch out Self Employed - Changes Ahead