The draft Finance Bill 2022 includes a major change to how partnerships and sole practitioners are taxed and will impact on many professional practices.
The proposals will mean that income tax will be based on actual profits arising in a tax year to 5th April rather than profits in the accounting year ending in the tax year. This will affect all partnerships and sole practitioners unless accounts are already prepared to 5 April (or 31 March). Where accounts are not prepared to 31 March, this will require apportionment of profits over 2 periods to adjust results to the tax year basis and may require estimates if accounts for the latter period are not yet finalised. In reality many practices are likely to change their accounting period end to 31 March.
This new method of calculating profits will apply from the tax year 2024/25, however the year of transition is 2023/24. In this tax year, many practices will experience double taxation as they will be taxed on 12 months of profits in the accounting year ending in 2023/24 plus profits earned from the end of their accounting year to 5 April 2024.
For example, in 2023/24 a practice with a year end of 30 April will be taxed on profits in the 12 months to 30 April 2023 plus 11 months of profits between 1 May 2023 and 31 March 2024, so a mouth watering 23 months! If overlap relief is available from overlap profits taxed in years of commencement of partners and sole practitioners, this will be able to be used against the additional profits arising in the transitional year.
Where additional profits remain after overlap relief this can be spread over 5 tax years to ease the overall cash flow burden. However, careful tax planning will be required in making this decision to avoid unintended consequences and potentially moving profits into higher tax bandings.
The tax year basis will simplify the position of joiners and leavers in professional practices and mean overlap profits will no longer apply but the transitional year will no doubt take some practices by surprise if they are not adequately prepared.
Now is the time to start planning for this change and to consider moving your year end to 31 March.
If you would like to discuss planning for the change in basis period please contact our EQ Professions team by calling one of our offices.