Switching taxation of the self-employed

by | Aug 26, 2021

In this blog post our Tax Consultant, Tim Palmer, takes a look at the practical workings of switching the taxation of a self-employed individual’s trading profits earned in the fiscal year.

The government has proposed that, in future, all sole trader businesses and partnerships should be taxed by reference to the profits they have earned in the fiscal year.

Businesses will not be required to make their accounts up to 5 April… They can still choose to make their accounts up to whatever accounting date suits them. However, they will see that from these changes, it will be much easier for them to have a 5 April year end in the future.

If their accounts are not made up to 5 April each year, they will have to apportion the profits of two sets of accounts to produce the profit earned for the tax year.

Under the current proposals, 2022/23 will be the transitional year, and the new regime will be fully in place for the fiscal year 2023/24. As mentioned above, this is very ambitious indeed!

It has become immediately apparent to me that this will require significant changes to the yearly timetable, under which accountants draw up their clients’ accounts.

To give you an example

Alfie, a self-employed builder, has a 31 December year end. Under the current regime, Alfie’s accounts for the year to 31 December 2023 would form the basis period for the 2023/24 tax year. Alfie’s self-assessment tax return for that year must be electronically submitted to HMRC by 31 January 2025.

Accordingly, at the moment, Alfie’s accountant has got 13 months to prepare and submit the accounts for the year to 31 December 2023.

However, under the new proposed changes, the 2023/24 SA tax return accounts’ taxable profit figure will be based on 9/12 of the profit to 31 December 2023, and 3/12 of the profit to 31 December 2024.

As a result of all of this, the reality of the position will be that the appropriate profit figure for 2023/24 will have to be reported to HMRC within one month of the end of the 31 December 2024 accounts! In reality, this will be almost impossible to do!

HMRC have recognised the problem in their consultation document, and state: “These businesses would normally be expected to use provisional figures to complete their tax return, and estimate the amount of taxable profit arising in the final months of the fiscal year. They would then have to submit an amendment to HMRC, when the final actual figures are available, to make the final apportionment.”

Personally, to me this seems extraordinary! HMRC have previously stated that they want to “simplify the tax system before Making Tax Digital is implemented”.  Any change that will require many businesses to estimate profits and then have to submit amended returns will not simplify the tax system… It has the potential to cause chaos!

We used to have this system many years ago in practice, with regard to property income for individuals. The first property assessment was issued on a preceding year basis, and then had to be amended to a current year basis when the client’s tax return had been submitted to HMRC. This caused a lot of problems in practice, it was extremely inefficient, and the system was therefore scrapped. It seems very strange that the government is now proposing that we effectively revert back to this type of system whereby we initially submit provisional figures, and then subsequently have to go through the rigmarole of amending them to an actual fiscal year basis when the final figures are available.

The impact of all of this

The government is proposing that 2022/23 will be the transitional year for this new regime.

For some taxpayers, this will be good news, because it will enable them to use up their brought forward overlap relief. However, for other taxpayers, there will be not such good news. For them, they will effectively have more than 12 months’ worth of profits being taxed in one year! This seems incredibly unfair and also will be quite complex for accountants to resolve and finalise.

Again, HMRC have recognised this and they are therefore proposing that there will be a facility to elect that the tax on these excess profits can be spread and paid over 5 years! This just seems to get more and more complex and increasingly complicated… so much for simplifying the tax system before MTD is implemented! If it had been me, I would have changed the basis of assessment first, had the transitional year, and then brought in the change to MTD once all of this had been finalised.

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