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Abolition of Basis Periods for Income Tax

Abolition of Basis Periods for Income Tax
26 Jul 2021
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Abolition of Basis Periods for Income Tax

On 20 July 2021, the Treasury and HMRC issued a number of policy papers and consultations flagging up possible future tax changes. Draft legislation for inclusion in the next Finance Bill has also been issued alongside some of the measures.

Among the documents these are probably the most significant:

Abolition of basis periods for income tax

A draft clause and Schedule propose to abolish basis periods for income taxed as trading profits for the tax year 2023/24 and subsequent years and provide transitional rules for the tax year 2022/23. These measures were announced as a “simplification” measure and will facilitate the introduction of making tax digital (MTD) for income tax which commences 6 April 2023. The changes will impact on sole traders, partnerships, property landlords and trusts that carry out trading or property rental activities.

The draft legislation provides for the apportionment of profits or losses of periods of account to tax years, where the period of account does not coincide with the tax year. Apportionment is to be done by reference to the number of days in each period, however the length of each period can be measured by a different method if it is both reasonable and used consistently.

A further draft clause changes the apportionment rules for property businesses, to allow those with property businesses who draw up accounts to dates between 31 March and 4 April to treat the profits between the end of their accounts and the end of the tax year as falling in the following tax year. It also allows those with property businesses commencing after 31 March to treat their business as commencing in the following tax year. This means they will no longer have to apportion small proportions of their profits between tax years.

Big tax bills in 2022/23?

The transitional rules proposed for the 2022/23 tax year could result in large tax bills for some sole traders and partnerships, particularly those with an existing 30 April year end. The profits of year ended 30 April 2021 would be taxed in 2021/22 under the current rules with 2023/24 taxing profits arising between 6 April 2023 and 5 April 2024 under the new rules.

But what about 2022/23?

The profits taxed in 2022/23 would be those for year ended 30 April 2022 plus the period 1 May 2022 to 5 April 2023 – in total 23 months profits!
There would however be a deduction for 11 months “overlap relief” which typically arose when profits were taxed twice at the start of the business - but those will often be much lower than the 11 months being taxed in 2022/23!

The draft transitional provisions will allow the taxpayer to elect to spread the excess profits over the next 5 tax years to smooth out their excessive tax bill.

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