Panellists

Lindsey Wicks, Senior Technical Manager, Tax Policy, ICAEW

Stephen Relf, Technical Manager, Tax, ICAEW

Richard Jones, Senior Technical Manager, Tax Policy, ICAEW

Producer

Ed Adams

Transcript

Lindsey Wicks: Hello and welcome to The Tax Track, the podcast series from ICAEW where we explore the latest developments in the world of tax and what they mean for our members and tax professionals alike. In this episode, we’ll be talking about basis period reform…

[Richard Jones: There are some very specific rules here around how that works.]

LW: …and looking ahead to what may be in store now we have a new government.

[Stephen Relf: A period of stability would be extremely welcome for businesses, so that they do have the confidence to invest and to grow.]

LW: I’m Lindsey Wicks, Senior Technical Manager for Tax Policy at ICAEW. With me in the studio this month is Stephen Relf, Technical Manager, Tax, and joining us down the line is Richard Jones, Senior Technical Manager, Tax Policy. Welcome to you both.

Basis period reform is an important issue at the moment. Stephen, can you tell us why?

Stephen Relf: Yes. So, traditionally, sole traders and partners have been taxed by reference to their basis period for the tax year. And the general rule is that the basis period is the 12-month accounting period which ends in that tax year. Now that’s probably best explained by an example. If you prepare your accounts to 31 December, then for the tax year 2022/23 your basis period would have been the year ended 31 December 2022.

Other rules do apply in certain situations, for example, when you begin to trade or when you change your accounting date.

If we go back to 2021, the government announced it wanted to move away from basis periods to the tax year basis, and that legislation has now been enacted. Quite simply, the tax year basis is that the sole trader or a partner will be taxed on their profits for that tax year. So that’s 6 April to the following 5 April.

So now we’re in a situation where tax years 2022/23 and earlier are on the basis period, tax years 2024/25 and later are on the tax year basis, and we have the tax year in the middle, 2023/24, which is a transitional tax year.

LW: And who’s this going to affect?

SR: The impact is going to be on sole traders and partners who prepare their accounts to a date other than 5 April. Now, when I say 5 April, I also mean 31 March, because there is an equivalence rule in the legislation which says that 31 March is treated as 5 April for these purposes. So the impact really is going to be on those taxpayers who prepare their accounts to a date other than 5 April. And the main impact is going to be on 2023/24, the transitional year.

In an early consultation document, the government did publish some figures for the number of people expected to be impacted, and that was roughly 528,000 sole traders and partners, which represents 7% of sole traders and 33% of partnerships.

LW: And how would the changes work?

SR: If we take 2023/24 first: that will be made up of two parts. You’ll have a standard part and a transitional part. The standard part will be the normal basis period, and the transitional part will cover the period from the end of the basis period to the end of the tax year.

On the face of it that clearly means that more profits will be taxed in 2023/24 than would otherwise be the case, but there are some compensatory measures. For example, in calculating for the profits for the transitional period, you can deduct any overlap profits which have been carried forward. Also, that transitional profit is spread over five years. And also, if you do happen to make a loss, there are enhanced loss relief available as well.

But it’s not just the transitional year. It will also be 2024/25 onwards, when we have the tax year basis. So in that case, if the sole trader or partnership continues to prepare accounts to a date other than 5 April, they will have to apportion their profits to the tax year, and they may also need to use estimated figures when they prepare their return.

LW: Richard, you’ve recently presented a webinar on basis period reform. What were the main issues raised by attendees?

Richard Jones: Well, one of the things that advisers have been struggling with at the moment is how to calculate and reflect overlap relief that’s included within the results for 2023/24 in order to offset against the profits that are riseable in that tax year.

SR: Richard, would it be possible just quickly to explain how overlap relief comes about?

RJ: What we’re talking about here is overlap profits, really, and overlap profits arise when a set of profits are essentially taxed twice. There are a couple of main situations where that arises. The first one is – or has been – when a business starts to trade and it starts with an accounting period that’s different to the tax year end. Under the commencement rules, you’d be taxed essentially on part of the profits in both years one and two.

Another situation is when the business changes its accounting period and has a shorter accounting period.

Essentially, what overlap relief is doing is giving you relief for the fact that some profits were taxed twice, but the relief up until this point was only available either when the business extended its accounting period or when it ceases to trade. As you can see, there’s a bit of a delay to the relief that’s available for something that might have been taxed decades earlier, but that’s essentially how overlap relief works and how it arises.

LW: And what concerns you, hearing from members about overlap relief?

RJ: One of the problems is, particularly if the overlap profits arose decades ago and the business has since changed its advisers, sometimes the information about the overlap profits hasn’t been transferred from the old adviser to the new adviser, or perhaps the existing adviser just hasn’t kept very good records. The problem then is when you come to use that overlap relief, not having the information available to know how to calculate it or to claim it.

HMRC has been aware of this, and it introduced an online form that you can fill in and ask for details of overlap relief that it holds on a particular business.

LW: That sounds like a positive thing.

RJ: It does. The form asks for quite a lot of information. You don’t have to supply all of that information, but the more that you can supply, the more clues, if you like, it gives HMRC as to where to look.

The problem has been that, as you might expect, demand has outstripped supply, and so HMRC’s response times have been extending over time. It’s been a case of HMRC applying a little bit more resource, which is great. We understand that, hopefully, that will start to reduce the waiting times. But obviously, as we get nearer to the filing date deadline, demand is going to keep ramping up.

LW: Is there anything that people can do to protect their position if they haven’t got the information?

RJ: Yes, one of the things that they could do, particularly as they’re getting close to the filing date, is to estimate what they think the overlap relief is and file a provisional return with a white space disclosure. And then once that information becomes available, they could then submit an amended return. That’s certainly the advice that HMRC has given to us and we would pass on to members if they find themselves in that position.

LW: Stephen’s already alluded to the fact that profits, the transitional part, net of overlap relief, are spread. Can you give me a quick overview of how that works?

RJ: The default position is that starting with the year 23/24, over the five years – so that year and the next four years – the default position would be to spread that transitional profit, less the overlap relief, evenly – so 20% each year. A business might decide to accelerate that. For example, if their standard profits for any particular tax year drop, and that then sends them into a lower marginal income tax rate band, they might think, well, if we tax more transitional profits at this point, that might use up more of our marginal income tax rate band.

LW: Which thresholds are and aren’t affected by the inclusion of transitional profits?

RJ: It depends. For example, payments on account of income tax are based on tax liability for the previous tax year, and obviously that will include the tax that you paid on your transitional profit. In that case, unfortunately, the transition profits will affect payments on account, but you can make a claim to reduce your payments on account. That might be particularly relevant, for example, in year six, the first year when the transitional profits come out of charge. If you think that tax payments on account are going to be based on year five, which of course will include the transitional profit, and that’s going to be unrepresentative of what the liability might be in year six, you might choose to claim then. That’s one situation where that might be relevant.

One of the other things we’ve been looking at is pensions allowance. Obviously, you have an annual allowance for the amount of contributions that you can make in a tax year that attract tax relief. That’s based on your earnings, and earnings for this purpose do include the transitional profits. But also your annual allowance can be reduced if you’re a higher income payer, and that’s if your adjusted income exceeds £260,000 in the tax year. That basically gets clawed back – so for every £2 you are above that threshold, you get £1 less of allowance, down to a minimum of £10,000. But for the purposes of defining adjusted income, that doesn’t include a transitional profit. So for pensions, you’re getting the best of both worlds there.

LW: Yes, that does sound good. And is there anything else that people need to think about in terms of transitional profits?

RJ: There are some individuals that in certain industries – for example, those that are making use of averaging elections, those are primarily people like creative artists, like authors, or people in the agricultural sector, like farmers – often their profits can fluctuate quite wildly year on year. There’s a scheme that’s been in for many, many years called averaging, which allows you to average out your profits for tax purposes. The general rule here is that that process takes place ignoring the transitional profit. You do the averaging first, then you add the transitional profit on at the end. In the webinar that we ran that you alluded to earlier on, there’s an example that we included. So if anyone wants any more information on that, refer to that, or also in the Tax Guide which we’re just updating, [there’s] some more of the FAQs that have come through on basis period reform.

LW: There’ll be links to all the webinar content in the show notes.

Now, Richard, these figures that are reported in the tax return – are there any issues to be aware of when completing the tax return, particularly for this transitional year?

RJ: Yes, one of the issues that arises is the fact that if you have a non-tax year end, you potentially have two accounting periods that have some relevance to tax in that particular tax year. And so in those situations – which isn’t only going to happen as a result of basis period reform, it could happen in other situations – you need to prepare multiple sets of supplementary pages, the self-employment pages, SA103.

There are some very specific rules here around how that works. When you submit a return, unfortunately, you’re only allowed to submit one main set of supplementary pages for self-employment. If you therefore have two sets, you have to submit one as an attachment to the return. So which is which? The broad rule of thumb is that you make the main set the latest set – the one relating to the latest accounting period – unless that period ends after the end of the tax year, in which case you can use the other period. Depending on when your accounting year end is, that will give you different results, and also depending on whether you change your accounting year end in 2023/24. There are also some new, special boxes that apply in 2023/24 on those forms, which again I won’t go into all the details here, but they are things like disclosing the amount of overlap relief that’s been claimed and the amount of transitional profit that’s included within the return. Once again, there’s details of that on our webinar and in the Tax Guide, if you want a step-by-step walkthrough on that.

SR: I guess as well, software plays a big part in this, doesn’t it? I know we’ve had some reports that maybe some software has had a few issues along the way. I guess when you do your tax return, you also need to consider any information that’s been put out there by the software provider.

RJ: That’s right. It’s good to check in, if you’re an adviser and you use a particular software product, to check in to how basis period reform is being reflected in that, and just to make sure it does agree with the guidance that we’ve been given from HMRC.

LW: And does the position change if you change your year end in the tax year 2023/24?

RJ: Yes. If we give another example here, let’s say that you decide in 2023/24 that you do want to move to the tax year end, and you do that by extending your accounting period – you’ve ended up with one long accounting period, and it ends at the end of the tax year. In that situation, you would only have one accounting period that’s reflected in 2023/24, so you’d only need one set of supplementary pages.

LW: Yes, and there are some special rules for 2023/24, or the normal rules are effectively overridden, aren’t they? Because normally you can’t have an accounting period of more than 18 months, but if you’ve got a 30 April year end, for example, or you did have and you change it to 31 March or 5 April, you effectively could have a 23-month accounting period for the 2023/24 tax year. And that’s actually acceptable, isn’t it?

RJ: Yes, certainly, for 2023/24 alone, that 18-month restriction is lifted. You might want to choose to do that to avoid the headache of having to pro rata results of two different accounting periods going forward, to work out what your tax year basis profits are. And particularly if you’re only doing that to defer tax, that’s not going to work any more. So probably we might find – and we know, actually, I’ve heard that a number of members are advising clients to do that – and whether or not you do that you’re still going to get taxed on 23 months’ worth of profits in 2023/24, so if you want to avoid the headache, you may as well go ahead and do it.

LW: We’ve spoken mainly about the self-employed and self-employment pages. How does this impact on partnerships?

RJ: There’s a couple of main things to say here. Firstly, we have the SA800 – that is the return that’s filed by the partnership. And that remains unchanged. In other words, basis period reform doesn’t apply to it, or at least you just pretend that it didn’t happen. You still would complete an SA800 based on the profits for the accounting period that ends in 2023/24. Obviously, if you had more than one, then you would file multiple SA800s. But if you only had one, then there’s only one set.

But of course, that potentially leaves partners in the lurch, because what about if there’s also an accounting period that needs to be reflected in 2023/24 but ends afterwards? In those situations, it’s advisable that the partnership issues two sets of partnership statements to the partners, reflecting their share of profits for each of those two accounting periods.

And then there are some extra new boxes, again applicable only for this year on the SA104, which is the supplementary pages for partners.

LW: And what are the issues beyond the transitional period if the accounting date isn’t 31 March or 5 April, for these businesses?

RJ: I think Stephen alluded to this a little bit earlier, in the sense that if you do have a year end that’s not the same as the tax year end, then you’re going to have to pro rata the results for each accounting period that falls partly within that tax year. Particularly, the later your accounting period end date is, the more likely it is that you won’t have the final results for the later accounting period. In that case, you might need to make an estimate of those profits and then file a provisional return and then go back and amend the return once you’ve got the final version of your results.

SR: Given the extra work you have to do, I would have thought that a lot of sole traders and partners would take that opportunity to change their year end and make it tie in with the tax year. But I know that HMRC assumes a lot of sole traders and partners won’t do that. Approximately 278,000 will continue with the current year end. Why do you think they would do that?

RJ: There are some businesses and industries where having a 31 March or a 5 April year end doesn’t make much practical sense. For example, tourism businesses – obviously things get quite busy around Easter. And when is Easter? Well, sometimes it’s before 31 March and sometimes it’s after. So you could potentially end up with a situation where a business has two Easters in one year and then no Easters in the next year, which doesn’t really make much sense in terms of reflecting their profit.

Another example is farmers: often they might have a 30 September or 31 October year end. The reason for that is because then they can reflect the profits they’ve got from selling their autumn harvest. I’m sure there are lots of other businesses as well, like international partnerships. Often they will have a 31 December year end.

LW: And finally, Richard, have you got any other top tips on this topic?

RJ: One of the things we’ve noticed more recently is a situation where a business might have previously had a non-tax year end and then they decided, for whatever reason, to change it to 5 April or 31 March. And at that time they would have been entitled, potentially, to use any overlap relief that was available to them, but they either just forgot, or they decided that they didn’t feel that they wanted to, because at that time it was perfectly voluntary. That means that they’re still holding some overlap relief to use. And in fact, you need to use any remaining overlap relief in 23/24. If you don’t, it’s going to be lost indefinitely.

LW: So it’s a “use it or lose it” situation?

RJ: Yes, exactly. But some businesses might not even realise that they have it. So it’s a case, I think, of looking back over old files just to check whether there has been a year end change at any point.

LW: Right. Thanks, Richard, for summing up the main issues for basis period reform – and as Richard’s alluded to, we do have a Tax Guide and a webinar available.

Now Stephen, you’ve been looking ahead to what the next Budget may contain. What are the expectations for businesses?

SR: We recently published a short article on what the next Budget may contain. To do that, we drew on the Labour Party’s manifesto and also some other documents that it published earlier in the year – in fact, before the election was called, and that includes one called ‘Labour’s Business Partnership for Growth’.

There were four standout measures for businesses, really. The first is a commitment that that main rate of corporation tax will not increase above 25%. Second, there was a commitment to retain the key capital allowances; in particular, that is full expensing and the annual investment allowance. Third, a commitment to maintain the current structure of the R&D tax credits, and also the patent box, and finally, to publish a roadmap for business taxation within the first six months of taking office.

Now, circling back to the R&D one, the Labour Party at that time did also say that they would crack down on fraudulent and incorrect claims for R&D tax relief, and also that they would evaluate the impact of R&D tax relief on a sector-by-sector basis, starting with the life sciences industry. On the roadmap, we haven’t got a huge amount to go on at this stage. At the time, the Labour Party said – and this is a quote – that the purpose of the roadmap would be to “allow businesses to plan investments with confidence”. And again, going back to that early document, the Partnership for Growth document, they did express an interest in trialling greater use of advanced rulings and clearances for major investment projects.

LW: That all sounds positive, because as we’ve discussed before, there’s been a lot of changes to the R&D tax regime over the last few years, and having a period of stability would be beneficial.

SR: That’s right. Assuming that we’re all happy with the current state of the R&D tax credits legislation and the way, for example, inquiries are undertaken.

LW: The compliance approach is something that we’re hearing a lot about, isn’t it, Richard?

RJ: Yes. It’s one of those areas where… I guess, going back a couple of years, HMRC had a lot of criticism from certain parties around the fact that a number of fraudulent claims were being let through, and so they had to do something to crack down on that. But what we’re finding is that it’s more measures that affect everyone, rather than just the fraudulent claimants. We’re certainly in ongoing discussions with them about how that could be improved so that genuine claimants are the ones that benefit from the regime but also aren’t penalised by it as well.

LW: In terms of the business roadmap, that sounds positive as well, but what sort of things do you think would be worthwhile to include? Because we’ve had a lot of measures trailed in the past, but not necessarily had that much detail as yet.

SR: Personally I wouldn’t overestimate the benefits of doing nothing. I think a period of stability would be extremely welcome for businesses, so that they do have the confidence to invest and to grow, and to not have to waste time trying to get their head around significant changes to tax legislation.

LW: The one thing that hasn’t been mentioned at all is employment status for tax, because we know that that causes a huge headache. You think the IR35 rules have been around probably almost a quarter of a century now, haven’t they, but I don’t think that’s delivered any certainty. Or we see numerous cases go through the tribunals and courts, and trying to assess what side of the line you fall is a huge headache for employers.

SR: Yes, it’s hugely complicated. And I think any effort to have a one-size-fits-all solution is going to have these problems. I think it’s definitely one that we don’t want to see any sort of quick action. You want to see a long period of consultation, where you can fully understand all the possible consequences of any possible decision.

LW: Are there any other significant changes likely?

SR: Another document that Labour published before the election that I haven’t mentioned yet was its plan to close the tax gap. That’s the difference between the tax HMRC expects to collect and what it actually receives. And during the election, we did actually get some updated figures. For the tax year 22/23 that tax gap stands at £39.8bn.

Now, in the manifesto, and in that document, Labour set out its plans to close the tax gap, and that’s all built around additional funding of £855m for HMRC, which the Labour Party believed would increase tax receipts and close the tax gap by £6bn. A lot of that investment will go into more staff, but also that additional resource will be focused on areas of tax risk. The Labour Party did also say that it would it was prepared to take strategically important criminal cases to act as a deterrent, and that it would change the law where it needed to tackle non-compliance.

It’s worth noting as well that in the last podcast we did focus on HMRC customer services, the poor state of customer services, and also on gaps in HMRC digital services. There is recognition from the Labour Party that both of those things have contributed to the tax gap, and the Labour Party in that document did promise improved HMRC services and to accelerate the modernisation and digitalisation of HMRC.

LW: That all sounds very positive, but it’s worth noting that at time of recording we still don’t have a date for the Budget. But by the time this goes live, we may.

SR: Let’s hope so, certainly, yes. The clock is ticking.

LW: That’s it for this episode. Many thanks to Stephen and Richard for your contributions… and thanks for listening. If you’ve missed anything, we’ve included some links for further reading in the show notes, and if you found it useful, then don’t forget to subscribe so you never miss an episode. You can rate and share the podcast too.

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