If your accounting year doesn’t tally up with the HMRC tax year, you could be in for an unpleasant surprise, warns Adam Bernstein

The way income tax payable by unincorporated businesses is calculated is changing, under new rules brought in by HMRC. But Revenue is worried that many have not heeded its warnings about how this will impact them. Put simply, some could be about to pay much more in tax and be burdened with unnecessary admin. 

The change to what is known as the ‘basis period’ rules will make little or no difference to businesses that already have a 5 April or 31 March year end. But as Emma Rawson, a technical officer at the Association of Tax Technicians, points out: “For those with accounting years that do not align with the tax year, the impact will be significant.”

She adds: “Many businesses who could be hit by this change remain unaware of it. The resulting temporary increase in their tax bills, and ongoing additional admin burdens, could therefore come as a nasty shock.”

What’s changing?

Currently, sole traders and partnerships pay income tax on the profits of their accounting year ending in the tax year. For example, if a taxpayer draws up accounts to 31 December each year, in the tax year 2022/23, it will be taxed on profits for the year ended 31 December 2022. From April 2024, this will change, and they will instead pay tax on the profits they make in the tax year – i.e. from 6 April to the following 5 April.

Rawson notes: “Tax year 2023/24 is a transitional year, in which the tax system swaps over from the current basis to the new tax year basis.

“To achieve this, special rules apply to calculate taxable profits and tax. Effectively, those that have a year-end other than 31 March or 5 April will be taxed on their normal basis period plus an extra amount of profits to bring them up to the end of the tax year.”

Rawson gives the example of a business with a 31 December year end that will be taxed on its profits for the year ended 31 December 2023 plus its profits for the period from 1 January 2024 to 5 April 2024.

This will result in more than 12 months’ worth of profit being taxed in 2023/24. To help ease any additional tax arising as a result, Rawson says that businesses can offset any ‘overlap profits’ they may have from their early years of trading (when they may have been taxed twice due to how the old basis period rules work). 

“They may also be able to spread any remaining ‘excess profits’ over up to five years,” she says. 

Admin burden

Rawson warns that the changes could give rise to an increased administration burden. In particular, she says that those who draw up accounts to something other than 31 March or 5 April will have extra work to do each time they complete their tax return.

“To get to the profits for a tax year, they will need to combine amounts from two separate sets of accounts and, depending on how late the accounting date falls, the second set of accounts may not be ready by the time they come to file their tax return.”

Where this is the case, Rawson says they will have to estimate the amount of profits to take from the second set of accounts and include a ‘provisional figure’ on their tax return. They will then need to amend the return to correct that provisional figure within one year of the original filing deadline (i.e. by 31 January 2027 for a 2024/25 return).

Irritatingly, these extra steps are not a one-off but will recur every year when they prepare their tax return.

Making the change

So, with the change set out, Rawson says the best way to avoid these ongoing burdens is to change the accounting date to 31 March or 5 April. It’s that simple.

Luckily, for the moment, it is possible to change the accounting date by drawing up a set of accounts for a shorter or longer period than usual, ending with the new accounting date.

The best time to do this may be during the transitional year 2023/24, believes Rawson. “Special rules applying in that tax year may allow them to spread any excess profits they have to bring into account over up to five years – something which isn’t available if they make the change in any other tax year,” she says.

“Another advantage of changing in 2023/24 is that the normal rule, which says a set of accounts can’t be longer than 18 months, is disapplied in that year. This means that they can draw up one long set of accounts to make the change.”

Reducing burdens

Unfortunately, moving the accounting date will not help the taxpayer escape any temporary increase in tax as a result in the change of the basis period rules. However, Rawson says it will reduce their ongoing admin burdens as they won’t have to worry about splitting accounting figures between tax years or estimating then correcting provisional figures.

This may also help to avoid a significant increase in fees for businesses that pay someone to prepare their self- assessment return. Tax return fees are likely to increase for businesses with an accounting date other than 31 March or 5 April, as agents will have to do more work to calculate the profits for the year, as well as having to amend returns to correct provisional figures. 

So, in Rawson’s view, “changing an accounting date to 31 March or 5 April will undoubtedly make a taxpayer’s life easier from a tax perspective.”

Before making any change, good advice is necessary to weigh up what’s best for the business overall. Time spent with an accountant or tax adviser in seeking more help and information would be a wise investment.