Self-employed and unincorporated farming businesses face difficult changes to taxation

By Heather Bright, Partner and ARA specialist

Every unincorporated business in the UK, including sole traders and the self-employed, will be taxed on income generated in the 12 months to 5 April each year from 2022-23, under plans set out in a new Government consultation.

Unincorporated businesses are currently taxed on income arising in the accounting period ending in a given tax year.

For example, an accounting period ending on 31 December 2021 would be taxed on earnings arising in the 2021 calendar year, rather than the 2021-22 tax year.

As a result, a business’s profit or loss for a tax year is usually the profit or loss for the year up to the accounting date in the tax year, called the ‘basis period’.

However, the reforms that have been proposed would mean that interim arrangements will apply to businesses that do not currently have year-ends falling between 31 March and 5 April each year.

These businesses will face a single tax bill from their year-end falling in the current 2021-22 tax year to 5 April 2023.

Because this period could be as long as 23 months, businesses are likely to see much higher profits than they would typically expect in a normal 12-month accounting period.

However, reliefs, allowances and tax band thresholds will be unchanged and will not be pro-rated, which could move some taxpayers into higher tax bands, while also reducing their ability to benefit from various annual reliefs and allowances.

Recognising the impact that this may have on taxpayers, HM Revenue & Customs (HMRC) proposes to require businesses to use all overlap relief accrued when they began trading during the transition year.

This would mean that businesses in this position will only have tax to pay on 12 months’ profits. However, overlap relief dates back to the first year in which a business traded, when it is likely to have been much less profitable.

Experts are concerned, therefore, that overlap relief will not be sufficient to offset the impact of additional profits above those they would typically expect to generate in a year – especially as many businesses will be more profitable now than in their first year of trading.

To soften the blow of this proposed change further, HMRC has proposed that businesses will be able to spread the payment for the transition year across the subsequent five tax years.

In addition to the direct impact of the transitional arrangements, businesses with year ends that have not aligned with the tax year will have a much shorter length of time between when they generate profits and when the tax falls due, which could have cash flow implications.

Importantly, non-trading income is unaffected by these changes as it is always assessed on a tax-year basis.

For the many unincorporated businesses that already have year-ends aligning with the tax year (which includes those falling between 31 March and 5 April), nothing will change.

However, for those with year-ends that are not synchronised with the tax year, there are several urgent considerations and careful tax planning may be necessary.