Written by Natasha Ryan
The long-term changes to partnership tax not only impact the way businesses plan, longer term, but also operate today. In this new era of business tax, unincorporated businesses- including sole traders and partnerships- will no longer be taxed based on their “accounts year” of trading profits, but, instead, on a “tax year” basis.
These changes- fully effective from 2024/25 with transitional rules applying in 2023/24- will impact any partner or sole trader firm that has not already adopted a 31st March or 5th April year end. A main feature of the new rules is to overcome the issue of overlap profits at the start of the business where some profits were taxed more than once, with relief for that only coming at the end of the business or on the retirement or leaving (or death) of a partner.
Effectively, the new rules mean that those businesses with non-tax year (ie a ‘tax year’ for these purposes being one ending 31st March or 5th April) accounting years are required to apportion profits or losses across this period, to adjust their results to ‘fit into’ the tax year. For any periods where accounts are not yet finalised, in order to meet tax return filing deadlines, provisional figures are likely to have to be used with amendments once accounts are finalised in order to ‘true up’ the tax assessment for the year. Although some of the rules on apportionments and provisional numbers are still to be rubber-stamped, the change to move to the tax year basis is however the new law.
So in practical terms, businesses who do not or cannot move their accounting period to fit in with the tax year (ie 31st March or 5th April year-end) will apportion two sets of results so there is an assessable amount for the tax year.
This is to be fully in effect for the 2024/25 tax year.
Before this, to facilitate the full change there will be a transition period, being the 2023/24 tax year, in which businesses will be taxed on a longer one off basis period running through to April 2024. So for example a business with an August 31st accounting date will be taxable on profits for the 12 months to 30 August 2023, plus 7 months of the profits to the 31st of August 2024. From this they will be required to deduct the aforementioned overlap relief which then disappears from the scene altogether. There is no option to defer the use of the overlap relief, it has to go in 2023/24
Although this is likely to result in higher tax assessments for 2023/24, this is an acceleration of tax due, as opposed to ‘extra’ tax. Crucially, it can either be spread over 5 years or taxed in full in one go (the spreading is the default position) and you can catch up by paying any part of the extra (called the transition profit) in that 5 year spreading period. In terms of income and tax planning these extra profits could obviously mean higher, accelerated overall levels of income and tax liabilities than has been plotted to date.
Although businesses can effectively simplify matters and change the year-end to align the accounting period with the tax year to avoid apportionment, not all can or will. For example, UK businesses in international partnerships or those with regulatory requirements may
struggle to fit everything into a statutory foreshortened tax reporting period and those with wholly seasonal businesses may not want to change if a March year end skews results as they have been captured historically.
One major impact to consider, is that the existing overlap relief will go ‘at a stroke’ in 2023/24. Any overlap relief accrued must now be used in that transitional year, effectively forcing the hand of older taxpayers that may have planned carefully on how to manage tax assessments during the later years of the business’ tenure up to a planned retirement date.
Additionally, the effect of higher taxable profits in these years of change needs to be borne in mind in terms of the possible effect on pension annual and lifetime allowances. Additional guidance is awaited from HMRC.
There is still practical detail for HMRC to clarify in the coming months but the above does summarise the shift in the plates.
Regardless of how businesses choose to respond to the changes, it is essential to seek professional advice. This will not only ensure businesses are prepared for the impact of any changes, it will also enable businesses to minimise the impact and take advantage of tax planning opportunities.