The way self-employment profits are taxed is changing.
We have summarised what’s happening and how you will be affected below.
What happens now?
At the moment, the income tax paid by sole traders and partners is based on the profits for the accounting period which ends during the relevant tax year. So, if the business accounts are prepared to 31 December each year, then the tax payable for the 2021/22 tax year which runs from 6 April 2021 to 5 April 2022 will be based on the profits for the year ended 31 December 2021.
What’s changing?
This will change from the tax year 2024/25 when we move to a tax year basis. The tax payable in that year will be based on the actual profits made from 6 April 2024 to 5 April 2025. This will, broadly speaking, include 9 months profits from the December 2024 accounts and 3 months profits from the December 2025 accounts.
In the (quite likely) event that the December 2025 accounts will not be finalised in time for the 2024/25 filing deadline on 31 January 2026, the Return will have to include estimated profits and an amended Return will be needed once the accounts are later finalised.
The good news is that businesses which prepare accounts to 31 March or 5 April will not be affected as their accounting period is already the same as the tax year. However, businesses with a different accounting year end will have to decide whether to change that year end or apportion their profits each year.
What happens in the meantime?
Tax years 2021/22 and 2022/23 will continue to work on the current basis, but there will be a transitional year in 2023/24.
In the transitional year, businesses will be taxed on their usual profits for the accounting year end, plus transitional profits which arise between the end of the accounting period and the tax year.
For example, if Sam has an accounting period ending on 31st July each year, profits will be taxed as follows:
- Their 2022/23 Return will include profits for the 12 months ending 31 July 2022
- Their 2023/24 Return will include profits for the 12 months ending 31 July 2023 plus profits for the period from 1 August 2023 to 31 March 2024 (transitional profits).
- Their 2024/25 Return will include profits from 1 April 2024 to 31 July 2024 and from 1 August 2024 to 31 March 2025.
There are two reliefs available for Sam to mitigate the impact of the additional profits being taxed in 2023/24:
- Any overlap profits that the business is carrying forward can be deducted in 2023/24. It will not be possible to carry forward overlap profits beyond this tax year
- Any transitional profits remaining after overlap profits are deducted can be spread evenly over five years from 2023/24 through to 2027/28. This is not compulsory!
What can I do?
If you don’t want to change your accounting year end, you don’t have to. However, you will have to apportion your profits for two accounting periods when preparing each Return, and depending upon timing submit estimated and then amended Returns each year. Clearly this will increase complexity and, potentially, the professional costs incurred for preparing your accounts and Tax Returns.
Changing your year end to coincide with the tax year will not avoid the impact of the transitional year and the additional profits charged, but would reduce that complexity going forwards.
If you are going to change your year end, you will only be able to spread those additional profits if the change happens in the transitional year 2023/24, so it’s likely to be beneficial to hold fire for now.
The decision will depend upon your own circumstances, and you should discuss this with your accountant.
Do you need more information?
The above is a summary of the main issues but of course there are many more – for example, what happens to losses, and what if the transitional profits take me over the £50,000 threshold for the High-Income Child Benefit Charge.
If you have any questions, or would like more information, please do get in touch.
