Change to how you calculate your tax liability

Since the introduction of self assessment in 1996, income tax has been based on the accounting period of a business. Each business can choose the date to which they draw up their accounts, and while many choose 31 March or 5 April, this is not the case for everyone.

Some farmers choose to have a year end date that fits with their specific farming activity; for example a September year end following harvest, or a December year end to tie in with bulk calving in the spring.

While this has the added benefit of giving more time to assess income tax liabilities, it has also given rise to complex calculations of tax liabilities in the first and last years of trade. HMRC now deem this to be unfair and feel that too many people are missing out on relief on the cessation of their business.

Therefore from 6 April 2024, HMRC are proposing to change the way in which tax is calculated for partnerships and sole traders. Tax will be calculated on a tax year basis and not on an accounting year basis. This means that 2023/24 becomes a transition year where more than 12 months profit may be taxed. For those businesses with a 31 March of 5 April year end, there will be no change. For businesses with a different year end however, this could lead to a substantial tax increase this year. Essentially you will be taxed from your last accounting date to 31 March or 5 April 2023/24.

For example, if you have a 30 April year end then your tax return for 2022/23 will be based on the profits to 30 April 2022. In 2023/24 however, you will be taxed on the profits from 1 May 2022 to 31 March 2024. This is 23 months of profit. There are therefore likely to be some high tax liabilities due by 31 January 2025.

You are however, able to relieve any overlap profits that you have brought forward. If we revisit the above example of a business with a 30 April year end, and assume it is a sole trader that made profits of £24k in the first year and £48k thereafter, the business would have overlap profits brought forward of approximately £22k. In the transitional year of change it would be taxed on approximately £70,000 of profits, after the relief of £22,000.

As you can see from this example, if the basis periods did not change then the individual would remain a basic rate taxpayer. However, the changes mean that the individual will now have tax due at the higher rate. Going forward the accounts would be drawn up to 31 March.

There are some ways to mitigate this tax liability. You can spread the excess profit (profit from the extra period, less the overlap) over the next five years. In the above example, £22,000 would be available for spreading so, instead of additional profit of £22k taxed in the year of change (£70k-£48k), £4,400 would be added to the total profits for each of the next five years. Assuming profits remain the same, this generates a tax saving of approximately £1.6k. It is also possible to adjust the spread to tax more in a specific year if profits decrease.

For some farmers five-year averaging may be available, however you can only average the normal profits and not the excess, therefore this will not be as beneficial.

Alternatively, businesses that prepare accounts to a date other than 31 March or 5 April, can choose to retain their current year end date. This would mean that going forwards their tax return would contain figures from two different accounting periods, each time apportioned to the tax year. This may result in estimates being included on tax returns as the accounts for the later periods may not yet have been finalised. For example, if you have a December year end then profits will have to be estimated from 1 January to 31 March each year in order to complete the tax return. Once figures are finalised then amended returns will need to be submitted. This could give some scope to reduce the larger profits in 2023/24. However, it will make the calculations complicated and involve additional tax computations.

If changing the year end is most likely it is important to consider whether an earlier change is beneficial. This would be the case if profits for the accounting year ending in 2022/23, or in the period from your year end to 31 March 2023 are likely to be exceptionally low.

Returning to the example above, let us assume that in the year to 30 April 2023 a tractor was purchased, and the capital allowance claim reduced the taxable profits to £4,000. The extra period of profits would be the same, so by changing year end a year earlier, the taxable profits are £26,000 in 2022/23 and £48,000 in 2023/24. As an aside, with these figures, 2 year averaging in 2023/24 would result in the same tax liability, but with a cash flow advantage of paying the tax at a later date.

As this example shows, these changes give rise to complex tax issues and potential large tax liabilities which should be considered in the cash flow. If you are concerned about how this may affect you then please do contact us.

As this example shows, these changes give rise to complex tax issues and increasing tax liabilities. If you are concerned about how this may affect you then please do contact us.