We invited Paul Aplin OBE back for a second deep dive into Basis Periods. In part two, Paul answers your questions off the back of the first edition. From MTD, to software capabilities, and the impact on tax deadlines, Paul leaves no stone unturned.
In my last blog I summarised the main points covered in our 9 December 2021 webinar on basis period reform. The webinar generated a number of questions, which we tried to answer in our second webinar on the topic on 1 March. This blog is a round-up of those answers.
Interaction with MTD: why estimate when we will have quarterly figures?
Under the new rules, if a business does not have an accounts year-end co-terminous with the tax year, it will have to time-apportion the results of any accounts spanning the tax year. If it has a 28 February or 31 January year end, then the accounts for the second year will not have been prepared by the time the tax return or MTD End of Period Statement (EOPS) is due.
In practice, the second year’s accounts are also unlikely to be available if the year-end is 31 December or 30 November (or perhaps even 31 October). Those businesses will therefore have to estimate the second year’s profit.
Originally – and for most of the past six years – we thought that the MTD for ITSA quarterly reports would relate to the accounts year. Last year HMRC confirmed that the quarterly reports would not align with the accounts year but with the tax year: They will run to 5 July, 5 October, 5 January and 5 April (or, by election, 30 June, 30 September, 31 December and 31 March). This means that basis periods and MTD for ITSA quarters will only align when the business has an accounts year coterminous with the tax year.
Businesses having to estimate the second year’s profits in an apportionment calculation will not, by definition, have accounts years coterminous with the tax year and therefore the quarterly reports will not help in estimating the second year’s profit.
Does all overlap profit have to be used up in the transitional year?
In a nutshell, yes.
There is an interesting provision in the Finance Act – Schedule 1, paragraph 79(1) – that allows you to claim any overlap profit in the transitional year that could or should have been claimed in the past. It is therefore worth checking to see if anything has been missed previously.
What if you don’t know the overlap profit?
In theory, the overlap profit should have appeared on the tax return (in box 70 of the 2020/21 SA103 or boxes 14 and 66 of the 2020/21 partnership pages SA104). In practice, it may have dropped off at some point due to a software update or for some other reason.
If it doesn’t appear on the current return, the next step is to look back – either in your tax software or copy returns – to see if you can find it there. If you do find it on an old return, remember to check to see whether the amount might have been reduced on a subsequent change of year end.
Failing this, you should ask HMRC. When this reform was first proposed, I was led to believe that HMRC had the figures – some people who attended our December webinar however said that they had called HMRC and been told that the figures were not available.
Recently, in a letter to the Chair of the House of Lords Economic Affairs Committee, the Financial Secretary to the Treasury said that HMRC “holds data on overlap relief where a business has, at some point, reported the amount of relief it has generated on its tax return” and that “this data can be provided on request”. The letter goes on to say that “where HMRC does not currently hold a specific record on the amount of overlap relief carried forward, it may be possible to identify overlap periods in past years’ tax returns and reconstruct a figure for overlap relief” and that HMRC is exploring the feasibility and resources required before committing to provide these figures. The letter also says that the government would like to inform businesses, if possible, of the figures HMRC holds in advance of the transitional year. I will be watching developments on this with interest.
As a last resort – if you have only recently started acting, or if old files have been destroyed – the client may have copies of old returns.
How can 31 March and 5 April be the same thing?
Section 8 of the Finance Act sets out special rules for property businesses with “late” accounting dates of 31 March 1 April, 2 April, 3 April or 4 April. These rules treat any profits of the period between the accounting date and 5 April as falling into the next tax year.
It is possible to elect for the rules not to apply (the election must be made on or before the first anniversary of the normal self-assessment tax return filing date for the first year the election is to have effect and it then applies for that year and the next four years). Effectively this treats “late” year ends as if they were coterminous with the fiscal year and avoids the need for apportionment in these situations.
Schedule 1, paragraph 7B has similar effects for non-property businesses.
There are examples in HMRC’s Business Income Manual at BIM81210.
Should every business change to a 31 March year-end – and if so, when?
I don’t think there is a hard and fast answer: every situation is different.
The first question to ask is: “why does the business not already have a fiscal year end?”. It may be because the trade is seasonal or because of stock valuation issues. Hospitality and farming would be examples where a non-fiscal year end has been chosen for good commercial reasons and it may well be that these commercial reasons are sufficiently strong to mean that the existing year end should be retained despite the difficulties that basis period reform will bring.
Where there is no pressing commercial reason to retain a non-fiscal year end, a change to 31 March or 5 April should be considered. Doing so would avoid apportionment, estimates and would align with MTD quarters.
Whether it will be best to change before the transitional year or in the transitional year will depend on the exact circumstances.
It should be noted that a change in the transitional year will mean that spreading of any additional profit over five years will be possible.
Can software cope with the changes?
Most of the main brands of accounting software that I have looked at do, though, I am told that with some, the process is less than perfect.
How much flexibility is there in spreading forward?
The default is to spread in five equal instalments over five years, beginning with the transitional year. Paragraph 73 of Schedule 1 does however allow the taxpayer to elect for an additional amount to be assessed in any of the five tax years which may be advisable if there are fluctuating overall income levels. There is a formula to calculate the amount falling into the remaining tax years.
If the business ceases before the entire transition profit has been assessed, the remaining balance is taxed in the tax year in which the trade ceases.
There are examples in HMRC’s Business Information Manual at BIM81310.
What are the knock-on effects on HICBC and pension contributions?
During the webinar, I realised it would have been helpful to have a slide showing the stages of the self-assessment tax calculation set out in Income Tax Act 2007, Section 23. Here is what would have been on that slide:
Step 1 TOTAL INCOME chargeable to income tax
Step 2 Deduct reliefs to arrive at NET INCOME
Step 3 Deduct allowances
Step 4 Calculate tax at applicable rates
Step 5 Total the tax at Step 4
Step 6 Deduct any tax reductions
Step 7 Add any additional tax to give TAX DUE FOR YEAR
When the basis period reform proposals were first announced, concerns were raised about the effect on means-tested benefits, the High Income Child Benefit Charge and pension payments. These concerns have been addressed by having two calculations: the first excluding the slice of the transition profit and the second with that slice included. The difference between the two calculations at Step 5 is the tax on the transitional profit. Because the income for means tested benefits, HICBC and pension payments is at Step 1 of the calculation, it is unaffected by the transitional profit. The Personal Allowance however is given at Step 3 and so is tapered in both calculations once income exceeds £100,000.
There are example calculations in HMRC’s Business Income Manual at BIM81320.
During the passage of the Finance Bill, concerns were also expressed about relief for overseas tax and the effect on EIS, SEIS and VCT relief. Amendments have ensured that The Finance Act gives relief for these elements at Step 6 so that they remain unaffected by the reforms.
What about other impacts, such as on enquiry windows and mortgage applications?
If a business does not have a year-end coterminous with the tax year, two years accounts will be involved in arriving at the taxable profit. As an enquiry notice will be in respect of a tax year, both sets of accounts will – based on my current understanding – therefore be open to enquiry.
Accounts are not of course only used to establish tax liabilities. Knowing how difficult it is to get some lenders to understand the current rules, I foresee problems explaining the relationship between two sets of accounts and a single year’s tax return. The critical thing is to prove the ability of the taxpayer to service the mortgage or loan payments and lenders will need to adapt their processes to ensure that this is recognised.
Will the changes impact tax payment dates?
At this point there will be no changes to tax payment dates. HMRC is interested in the idea of more closely aligning profits and the associated tax bills, indeed this was a factor in the decision to proceed with basis period reform. I therefore suspect that in time we will see changes to tax payment dates, possibly based on MTD quarterly reports and in-year calculations – but not for a while.
Do you apportion on days or months?
The Finance Act – Schedule 1, paragraph 3 – says days, but that a different method may be used if it is reasonable to do so and the method is applied consistently. HMRC’s Business Income Manual at BIM81201 says that acceptable alternatives might be weeks, months or where more accuracy can be achieved because of there being a few transactions: this could potentially cover the situation where a significant transaction takes place on a date in an accounts year that falls outside the particular tax year in question.
How do the rules affect partnerships?
A partner will have to calculate based on the 2023/24 basis period for their notional trade. Each partner in a partnership will have to calculate their own position using their personal overlap profit calculation. Some overlap profits will have arisen many years ago and in addition to the options set out above, a partner struggling to find their overlap profit figure might also consider asking other partners if they happen to have a copy of the calculations for the relevant year’s return – I know from experience that some partners retain information which others don’t!
Partnerships with overseas income will have breathed a sigh of relief over the alteration to the tax calculations enabling credit to be given for overseas tax paid at Step 6.
What are the options for losses – are there limits on the terminal loss?
If, by virtue of a deduction for overlap profit under the basis period reform provisions, the trader makes a loss for 2023/24 where there would otherwise have been a profit, or makes a loss greater than would otherwise have been the case, the loss (or increase in loss) is treated as a terminal loss as if the trade had permanently ceased on 5 April 2024. Such a loss can be thrown back up to three years. There is more information in HMRC’s Business Income Manual at BIM81300.
The main thing we don’t yet know is how the mechanics of estimating will work. HMRC set out some possible options in the consultation response document on 4 November 2021:
- allowing taxpayers to amend a provisional figure at the same time as they file their return for the following tax year
- allowing an extension of the filing deadline for some groups of taxpayers, such as more complex partnerships or seasonal trades
- allowing taxpayers to include in the next year’s tax return any differences between provisional and actual figures in the previous year
- leaving the current rules on provisional figures unchanged, whereby profits can be estimated in a return and amended as soon as final figures become available
It remains to be seen which of these will be chosen but as – based on HMRC’s own assessment – 278,000 businesses could have to estimate profits as a result of basis period reform, it is to be hoped that it will be the least burdensome method.
We will also see software developers incorporating the new rules into their products and hopefully ensuring that year end changes are easy to make.
And we will doubtless encounter other practical issues along the way.
If you missed the webinar, you can find the full recording by clicking here. Paul, alongside our very own VP Product Accounting Strategy, Paul Lodder, discuss all of these questions and more in greater detail.