Basis period reforms signal full speed ahead for Making Tax Digital
Proposed reforms to tax calculations for the self-employed, announced today, are a clear indicator that the government remains committed to an April 2023 implementation of Making Tax Digital for income tax, says the Chartered Institute of Taxation. However, the Institute has reservations over the pace of the change.
Draft legislation1 published alongside a consultation document2 today outlines the government’s plans to reform the ‘basis period’ rules which determine how trading income for unincorporated businesses (that is, self-employed sole traders and partnerships) is allocated to tax years.
The proposal is to change the allocation so that it will be based on the profits or losses arising in the actual tax year, rather than (as now) in accordance with the accounting period ending in the tax year. The new ‘tax year basis’ will apply from the tax year 2022-23, in advance of the expected start of Making Tax Digital (MTD) for income tax self-assessment (ITSA) in April 20233.
As part of the reform, legislation will also be introduced to formally deem 31 March as equivalent to 5 April meaning that businesses which draw up accounts to 31 March will not have to make small apportionments of a few days to determine their profits or losses for a tax year. This equivalence already tends to happen in practice but this will put it on a statutory footing.
Commenting on the proposal, Pete Miller, Chair of the CIOT’s Owner Managed Business Committee, said:
“This is a welcome simplification of the current system which has been with us in one shape or form since the 1920s, but we are concerned about the speed at which it is being introduced and whether there will be enough time for businesses to absorb the impact of the change on their individual circumstances and take action to avoid any adverse or unforeseen consequences.
“We are also concerned that the government consultation on this reform is inadequate. Six weeks during the holiday season, in the middle of a pandemic, is not sufficient for tax professionals and others to assess the detail of this significant change, how it will affect them and their clients, and provide constructive feedback to government on it.”
Whilst the change will have little or no impact on the majority of businesses who already use either the 5 April or 31 March as their accounting period end, it will introduce complexity for businesses that don’t have an accounting period end which matches the tax year4.
This will often be for commercial reasons such as the seasonality of their business or to reflect the sector in which they operate. They will be required to time-apportion their profits into the appropriate tax years, adding complexity to one part of the tax system in order to bring simplification to another. Also, businesses with an accounting period that ends later in the tax year may have to use estimates if their accounts have not been finalised by the time they need to submit their self-assessment tax return to HMRC.
CIOT believes this will effectively force these businesses to change their accounting date to 5 April or 31 March in order to avoid this additional complexity. This may not be an issue for some businesses, but undoubtedly there will be some who will want to continue to use their existing accounting date for commercial reasons. These businesses will need to quickly weigh up the costs and benefits of keeping their accounting date compared to moving it to 5 April or 31 March.
The proposal means that overlap relief5 - which can be difficult to understand and calculate especially for taxpayers not represented by an agent - will no longer arise. This is a welcome simplification.
The transition to the new basis of calculation will mean that more than 12 months' profits could be taxed in 2022/23, although the government will allow overlap relief brought forward to be offset against this.
The government will also allow any ‘excess’ profits to be taxed over a five year period. While in theory this should mitigate any adverse impacts of taxing more than 12 months’ worth of profits in 2022/23, we wonder how many businesses and agents, or indeed HMRC, have reliable records of overlap relief. HMRC may need to take a pragmatic view if we are to prevent a large number of disputes around this.
It is likely that businesses without agents that don’t already use 5 April or 31 March as their accounting date will need help to understand what these changes mean for their businesses. HMRC will need to devote resources to ensuring that these taxpayers aren’t left behind by these changes, otherwise they could end up facing significant difficulty complying with the new rules.
Pete Miller continued:
“The main driver for reforming basis period rules is MTD. This proposal is intended to reduce the number of quarterly submission dates from at least thirteen6 a year to eight7, reducing the compliance burdens on most businesses, and we welcome that.
"But we are concerned at the very tight timeframe in which the changes will take place. We have been highlighting for years that MTD could mean some taxpayers facing significant burdens as a result of having to make multiple quarterly updates to HMRC each year depending on their individual circumstances, and whilst it is pleasing to see the government address this, it is regrettable that it seems to be being done at the eleventh hour, with little time for ironing out any problems which emerge.”
CIOT understands that for the purposes of MTD quarterly reporting HMRC are intending to make all unincorporated businesses submit quarterly reports in line with calendar quarters8 (or 5 April) irrespective of their actual accounting period end date.
Whilst the details are still sketchy, we anticipate that this could lead to significantly increased complexity for the minority of businesses whose accounting period end does not align with a calendar quarter end date and will be another reason why businesses may end up choosing to change their accounting date to align with either 5 April or 31 March.
Formally deeming 31 March as equivalent to 5 April is, we believe, also likely to mean that unincorporated businesses will need to follow the rules for MTD for ITSA from their next accounting period starting on or after 1 April 2023, rather than 6 April 2023.
Pete Miller concluded:
“Ultimately, we would have preferred the start date for MTD for ITSA to be deferred in order to accommodate a more thorough consultation process and give businesses more time to absorb the impact of the change in the basis period rules before they transition into the MTD regime.”
3. MTD for ITSA is being introduced from April 2023. Self-employed businesses and landlords with annual business or property income above £10,000 will need to follow the rules for MTD for ITSA from their next accounting period starting on or after 6 April 2023. They will need to use software to keep digital records and send quarterly and end of year updates to HMRC instead of filing a Self Assessment tax return.
4. We understand that up to half a million unincorporated businesses have a year end other than 5 April or 31 March.
5. The current rules mean that new businesses can be taxed on the same profits twice when they start if they don’t choose either 5 April or 31 March as their accounting period end date. This generates “overlap profits” which are carried forward and can be used to claim “overlap relief” when the business ends. HMRC note in the consultation published today that the rules on overlap relief are an area of particular complexity, with most eligible businesses not claiming the relief when they should. These businesses may not know they are eligible to use relief, do not know how to calculate relief, or may have lost track of their relief over time.
6. On the assumption that an unincorporated business has self-employment and property income and is VAT registered, but with non-coterminus quarter ends.
7. The proposal aligns the self-employment and property quarters, thus removing one set of quarterly updates, and aligning the end of year update with an existing deadline.
8. Ie 31 March, 30 June, 30 September and 31 December.