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Tax year basis is law, but problems remain

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Around 400,000 unincorporated businesses will be affected by the switch to the tax year basis in April 2024, but problems over interest and penalties are unresolved.

11th Mar 2022
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From 6 April 2024 all unincorporated businesses need to report their income and expenses to HMRC as they arise in the tax year (the tax year basis). This has been legislated for by Finance Act 2022, Schedule 1 which abolishes all basis periods for income tax (new ITTOIA 2005, ss 7A-7D).

All sole traders, partnerships and limited liability partnerships (LLPs) will have to use the tax year basis from 2024/25, which coincides with sole traders being mandated into Making Tax Digital for Income Tax Self Assessment (MTD ITSA). However general partnerships won’t enter the MTD ITSA regime until April 2025, and there is no published start date for LLPs to commence MTD ITSA reporting.  

Those businesses that already draw up accounts to 5 April will see no difference to their tax reporting. Businesses that have a 31 March year end also won’t be greatly affected, as accounting periods that end on any of: 31 March, 1, 2, 3, or 4 April will be treated as ending on 5 April. Any income and expenses in those last few days of the tax year, falling after the accounting period end, will be treated as arising in the next tax year.   

Serious inconvenience  

HMRC has stated that around 7% of sole traders (around 250,000 businesses) and 33% of partnerships (130,000 businesses) don’t use an accounting period that ends close to 5 April, but it has not provided the data to back up these statistics.

Those businesses can carry on drawing up their accounts to a date that is not 5 April (or near), but they will then have to apportion profits from two accounting periods to fit into the tax year – for 2024/25 and every subsequent tax year. This pro-rata of profits should be done on a day count basis, or by using any time apportionment that is reasonable and applied consistently.   

It is likely to be the more complex international partnerships and seasonal businesses that will need to pro-rata accounting results into two tax years. Thus, although the numbers of businesses affected may be relatively small, the amount of income tax paid by those businesses may be significant.  

Capital allowances 

Capital allowances will continue to be determined on an accounting period rather than a tax year basis, as the legislation regarding those allowances has not been changed. Businesses will account for capital additions, disposals, and writing down allowances for each accounting period. 

The net profits of the accounting period, after deduction of allowances, will form the overall taxable profit/loss for that period. Where the business does not use a tax year end for its accounting date, the result will be allocated to the appropriate tax years on a pro-rata basis.  

Problems with pro-rata

The major problem with having to pro-rata accounting results from two accounting periods into one tax year is the tight deadline for filing the end of period statement (EOPS). This may result in provisional profit figures being filed for every tax year, and the resultant tax liabilities having to be adjusted at a later date. 

Here’s an example. UKRN is a general partnership with draws up its accounts to 31 October. For the tax year 2025/26 it will need to apportion profits from its accounts to 31 October 2025 and from its accounts to 31 October 2026. But UKRN will have only three months to 31 January 2027 to finalise its 2026 accounts, before the EOPS and finalisation statement for the partnership for 2025/26 are due to be filed.

UKRN may have to estimate some figures in its 2026 accounts in order to report profits by 31 January 2027. This would mean that the tax payable by the UKRN partners for 2025/26 would be based partly on estimated profit figures. 

Both the reported profits for 2025/26 and the partners’ tax liabilities will have to be adjusted when the accounts to 31 October 2026 are finalised. This raises questions about interest and penalties due on late payments, and penalties for inaccurate returns.

HMRC is considering options for how to deal with these issues, and it is talking to the professional bodies about possible solutions. Any decisions will be made by autumn 2022.

Why is this change needed?

As I reported in November 2021 in my article on tax year basis transition, HMRC insists that the tax year basis is critical to the operation of MTD ITSA, as without it the quarterly update figures won’t provide a meaningful estimation of the tax due by the business for the year. 

I hate to break it to HMRC, but the quarterly update figures are not going to provide any meaningful basis for the annual tax charge for the majority of businesses, except perhaps for very simple businesses that use the cash basis. 

The pro-rata of profits/losses from two accounting periods won’t impact the MTD ITSA quarterly updates at all, as those updates report only raw transactional totals arising in the quarter. It is only the EOPS that requires a complete and correct report of accounting profits, and the Finalisation Statement which incorporates the EOPS results plus any other taxable income, allowances and claims.

HMRC guidance 

HMRC has added a new section to its business income manual at BIM81200 that deals with the tax year basis and the transitional rules for 2023/24. There is a useful list of examples concerning the tax basis at BIM81360

The ICAEW Tax Faculty will shortly be publishing a tax guide on the tax basis, focusing on the practical problems accountants need to address, such as when or if to change an accounting year end.  

Transitional nightmares 

The transitional year 2023/24 has the potential to create some serious tax headaches, and I will cover those in a later article.    

 

Replies (23)

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By Hugo Fair
11th Mar 2022 14:25

"I hate to break it to HMRC, but the quarterly update figures are not going to provide any meaningful basis for the annual tax charge for the majority of businesses, except perhaps for very simple businesses that use the cash basis."

Obviously no disagreement with that comment, Rebecca, but given how often it's been said (and by a LOT of people for well over a year) ... is there any sign that HMRC is listening? And if not, why?

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Replying to Hugo Fair:
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By brianheg
14th Mar 2022 11:02

The cynic in me says its because this affects small businesses.

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By Paul Crowley
11th Mar 2022 14:48

Superb article

Agreed Quarterly tax computations are without value and always will be
And that is supposed to be the basis for changing the rules?
What a joke that HMRC could no easily mislead the Government

Thanks (11)
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By GHarr497688
11th Mar 2022 18:40

Forcing people to use computers is dictating how you should run your business . Changing the basis period does the same . When you then see that these quarterly updates are meaningless is just wrong . No cost benefits, accuracy compromised , choice taken away , inconvenience to taxpayers and risk of error . Stop this madness now .

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By AndrewTall
14th Mar 2022 10:34

I note that it is worse than you say Rebecca:

"I hate to break it to HMRC, but the quarterly update figures are not going to provide any meaningful basis for the annual tax charge for the majority of businesses, except perhaps for very simple businesses that use the cash basis. "

For the quarterly cashbooks submitted to give an accurate estimate of the annual tax charge:
1. The business needs to have no seasonal variation in profits
2. The basic book-keeping data needs to be flawlessly accurate containing no personal expenditure or other non-business income/expenditure
3. The business either needs to be cash-basis or have no profit impact from the application of 3.5k pages of GAAP
4. The business needs to have no expenditure which is disallowed or have its deduction deferred by 25k pages+ of tax legislation

At which point I suspect there is a significant risk that the business is likely to be caught by IR35 and/or they can accurately estimate their tax liability from just their turnover making the 1/4ly filing exercise pointless for them as well.

Thanks (6)
Replying to AndrewTall:
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By GHarr497688
14th Mar 2022 14:08

It's quite concerning that the individual who are making up these tax rules can't have any knowledge of the methods used to produce a set of Accounts. I would suspect the Computer bods are advising . I have noted that SAGE share price is increasing whilst most other share prices are falling.

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By MC1
14th Mar 2022 10:38

UK PATCHWORK PLASTERS again.

Problem: We've employed incompetent managers
Solution: Employ some more incompetent managers to sort them out

Problem: We've introduced a useless system (MTDITSA)
Solution: Introduce another useless system (change of basis period) to sort it out

Nobody can criticise us for being afraid of change.

Thanks (5)
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By minkie
14th Mar 2022 10:39

Thank you for the information - good to have some clarity as I have found the information from HMRC to be quite unhelpful. As a sole practitioner, I have been worried about the possibility of having to be up to date by the end of the first quarter for businesses with a non April year end. It's all rather stressful for no perceivable benefit

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Replying to minkie:
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By MartinLevin
14th Mar 2022 10:58

Whatever happened to "free choice"?
We (still) live in a "free" society, and this adds more complexity with advisers. I dread to think HOW the do-it-yourself business will ever cope (without us). I have always remind HMRC, that traders are not book-keepers.

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David Ross
By davidross
14th Mar 2022 10:41

Thank you, Rebecca, for the first intelligent article I have seen on this subject - as far as international businesses are concerned. But then one supposes that these Gods, whilst constrained to use odd accounting dates by the laws of other Countries, also have the resources to cope, poor dears. Some of them who are UK based will already have to cope in reverse with the reporting rules in those other Countries.

But seasonal businesses? I have never understood this one. Once the change has taken place (as should have happened if only the Government of the Day had had the will at the start of Self Assessment) what is the difference?

In truth this has always been for the convenience of accountants who want to spread their work over the year.

As for 'being made to use a computer' that, and quarterly accounting, is all about improving record-keeping (the point of the exercise) and I say Bring It On. I'm about to get our clients' data fed to me on a daily basis and won't have to beg for it for months after the fact. This 65 year old considers that Manna from Heaven

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By agknight
14th Mar 2022 10:51

Given that replies to this article are 100% negative about this change and mine are also. Can AW do an article summarising for us how our accountancy bodies are representing us in getting the Government to see some sense as to what they are doing to small businesses, the backbone of the UK economy.

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Replying to agknight:
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By MartinLevin
14th Mar 2022 11:02

Back in 1974(ish) a retired Speaker of the House of Commons (Sir Bernard Wetherall) stated that "around 95% of businesses in the United Kingdom, employ 5 or fewer employees; and yet the government treats each the same as if it were the size of ICI" [the largest company in the UK at the time].
Has nothing changed?

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Ivor Windybottom
By Ivor Windybottom
14th Mar 2022 10:59

Why, oh why don't HMRC just be honest and say they want quarterly payments on account, in advance?

While business may not like the cashflow impact it is can be dealt with and would be simple. CT has done it for larger businesses without too much fuss.

Obviously it makes sense to start with the large tax liabilities first as those businesses have resources to do the admin and it brings in the most money. Perhaps a threshold of £50,000 tax would sort this car crash out?

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By Mr J Andrews
14th Mar 2022 11:44

Still no mention of how those HMRC customers - exempt from MTD for whatever reason - will be affected.

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Replying to Mr J Andrews:
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By MartinLevin
14th Mar 2022 12:28

"Customers" implies a choice, whereas HMRC is a monopoly. Why can't we use "taxpayers"?

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Replying to MartinLevin:
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By Mr J Andrews
14th Mar 2022 14:23

Mea Culpa. I omitted the quotation marks for ''Customers''

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By Charlie Carne
14th Mar 2022 16:38

Excellent article, as always. Rebecca. Do we have any news yet as to whether the rule that the dates 31 March, 1, 2, 3, or 4 April will be treated as ending on 5 April will apply to rental income as well as trading accounts? If a sole trader can draw up business accounts to 31st March, it will add huge complexity to MTD if that same taxpayer needs to continue to use 5th April as his year-end for his rental income.

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Replying to charliecarne:
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By Ardeninian
15th Mar 2022 12:21

The equivalent rule for property businesses is in new section 275B ITTOIA (introduced by section 8 FA22). The calendar quarters election for MTD applies to property businesses in the same way as it does to trading businesses - so you can draw both trade and property up to 31/3 and treat them the same for MTD.

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By B.R.
15th Mar 2022 10:32

I tried to move my client partnership from 31 July year end to 31 March year end, but was told that a change involving a more than 18 month period of account was not possible!

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Replying to B.R.:
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By AndrewTall
15th Mar 2022 11:48

Somehow I suspect from your comment that they didn't immediately go on to say, "oh but of course you can reduce the period by 4 months so that's obviously what you meant..."

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By AndrewV12
15th Mar 2022 11:07

similar TO ABOVE, THE 4TH QUARTERS FIGURES AND final accounts may well be significantly different to the previous 3 quarters figures.

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Morph
By kevinringer
24th Mar 2022 15:19

We all know that HMRC's argument "HMRC insists that the tax year basis is critical to the operation of MTD ITSA" is wrong because the proposal actually ignores the MTD ITSA profits for the period after the end of the accounting year, and instead an apportioned estimate of the whole of the following accounting year is used. The new regime replaces the existing certainty with future uncertainty as it will be necessary to estimate future profit and revise the estimate several times during the year. It looks like it will be possible to claim tax relief in advance. For example, y/e 31 December carries out major building repairs autumn 2028 which means 3/12 will be brought into the previous tax year 2027-28. All these points seem to defeat HMRC's arguments for the new basis periods. Therefore, why are HMRC making this change?

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Replying to kevinringer:
Morph
By kevinringer
24th Mar 2022 15:22

Just a thought: in the early days of MTD HMRC clearly thought all businesses already used accounting software and all they needed to do was the press the button to file their VAT and ITSA returns. HMRC seemed to genuinely not appreciate that many businesses have spreadsheets, manual records, or (99% of them) "incomplete" records ("incomplete" could be as little as a CIS tax certificate). The new basis periods require businesses to forecast their income, and to revise that forecast as the year progresses. Could it be that HMRC assume all businesses not only use software, but also use the software's budgeting/forecasting functions?

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