Consultation outcome

Basis period reform - consultation

Updated 4 November 2021

Summary

Subject of this consultation

This consultation asks for views on how best to implement a proposal to simplify the rules under which profits of an unincorporated trading business are allocated to tax years using basis periods.

Scope of this consultation

This consultation outlines the current rules for basis periods, sets out a specific proposal to simplify them and suggests transitional rules for moving to the new system. The aim is to simplify the system before Making Tax Digital is implemented. We are publishing draft legislation alongside this document.

The proposal affects the self-employed, partnerships, trusts, and estates with trading income. The proposal will not affect companies except for some non-resident companies. Affected groups are collectively termed ‘businesses’ in this document. The proposal mainly affects unincorporated businesses that do not draw up annual accounts to 31 March or 5 April, and those that are in the early years of trade.

Having carried out a short informal consultation with a range of businesses and tax experts, the government intends to implement the proposed reform ahead of the mandation of Making Tax Digital for Income Tax. The consultation seeks views on the detailed policy and which businesses are likely to be most affected by the proposal, what benefits it is likely to bring and how best to minimise the downsides.

Who should read this

We would like to hear from businesses, their advisers, representative bodies, tax software providers and other interested parties.

Duration

The consultation will run for 6 weeks from 20 July 2021 to 31 August 2021.

Lead official

T Brown, HMRC

How to respond or enquire about this consultation

Any queries about this consultation should be directed to T Brown or D Shaw by email to [email protected].

Additional ways to be involved

HMRC officials are willing to meet online with interested parties to discuss any aspect of this consultation.

After the consultation

The government will consider whether to publish a summary of responses alongside any decision on the detailed implementation of the proposal, which will be announced later in the year.

Getting to this stage

This proposal was suggested as a simplification opportunity in the government’s call for evidence The tax administration framework: supporting a 21st century tax system published on 23 March 2021. The government has also recently carried out a short informal consultation with a cross-section of interested parties to test the general feasibility of the proposal.

Previous engagement

In 2014 the Office of Tax Simplification recommended simplifying basis periods, and although they did not make a specific simplification proposal, they recommended a review of the complexities in the opening years of a trade and a review of overlap relief.

A consultation, Simplifying tax for unincorporated businesses, which included proposals to reform basis periods, was published in 2016. A summary of responses to this consultation was published in 2017. The proposals contained in this consultation are significantly different to the proposals included in the consultation of 2016.

Foreword

In March 2021, the Treasury published a Call for Evidence on the government’s tax administration framework, part of our 10-year strategy to create a tax system fit for the challenges and opportunities of the 21st century. There we set out a vision for a fully digital tax system which is better able to support the emerging needs of taxpayers, which is fair and even-handed and builds trust over time, and which works closer to real time, so that people can pay the right tax with ease while they work, live their lives, and run their businesses.

The government has already announced plans to mandate Making Tax Digital for Income Tax for self-employed people and business partnerships with annual income above £10,000. This further move towards a digital tax system is designed to give business taxpayers a more up-to-date understanding of their tax position. It will remove opportunities for error, so that the right tax is paid.

This was and remains an ambitious vision for the future of the tax system. However, I believe we can go further, to challenge an area of tax administration which has become entrenched over the last 100 years, by reforming the complex basis period rules for taxing income from self-employment.

Chapter 4 of the Call for Evidence included a proposal to this effect. The current rules date back to the mid-1990s and are themselves derived from a system that dates back to the 1920s. The rules are straightforward for the 93 per cent of sole traders and 67 per cent of business partnerships that draw up their annual accounts for a period that is aligned with the tax year ending on 5 April (or 31 March, which HMRC normally treats as equivalent to 5 April). But choosing an accounting date different to the tax year-end creates complexities that lead to businesses making many thousands of tax return errors every year. While large firms and those with professional advisers understand the rules and find them straightforward to apply, less sophisticated taxpayers find the rules opaque, illogical and unfair. Tellingly, more than half of businesses affected by this complexity do not claim the relief they are entitled to.

By taking a fresh look at the fundamental building blocks of the tax system, the government now has the opportunity to design a system that is simpler, easier to navigate, and more responsive to taxpayers’ needs. The proposal we are putting forward today will simplify the basis period rules for self-employment income, aligning them with the rules for other types of income so that they are more logical and easier to understand. It will remove the complexities that lead to unclaimed relief, and will reduce the number of different quarterly reporting dates under Making Tax Digital for businesses with both self-employment and property income.

We have already carried out a short informal consultation with a range of tax experts to test the general feasibility of this proposal, and it has been widely welcomed as an important potential simplification. We now want to talk to a broader range of interested parties about the proposal and its potential consequences. I hope that a wide range of people and organisations respond to this consultation, so that the government can draw on the very best ideas in its continuing efforts to design a tax administration system fit for the 21st century.

Rt Hon Jesse Norman, Financial Secretary to the Treasury

Executive summary

This consultation document proposes a simplification of the income tax system to support small businesses, helping them spend less time filing their taxes and making the rules fairer, more logical and easier to understand.

The government has engaged with a cross-section of stakeholders representing a wide range and size of businesses, in a variety of sectors, in order to establish initial impacts and is now seeking detailed views on the proposal.

The aim is to deliver reform in advance of the government’s plans to provide self- employed business owners with a more modern, digital, integrated service through the implementation of Making Tax Digital for Income Tax. This would help reduce errors and ensure self-employed businesses get their tax right first time.

The reform would mean businesses would simply be taxed on profits arising in a tax year, aligning the way self-employed profits are taxed with other forms of income, such as property and investment income. The new system would apply to all sole traders and partnerships, ensuring simplicity and fairness is at the core of the tax system, preventing many thousands of errors every year.

The change to the time periods against which businesses report their tax would also reduce the number of times those with several sources of income would need to report their income under Making Tax Digital for Income Tax. Under the current system, tax returns filed by the self-employed, sole traders and partnerships are based on a business’s set of accounts ending in the tax year. More complex rules apply when a business starts and finishes. Many new businesses are taxed on the same profits twice when they start. This generates “overlap profits” which are carried forward and can be used to claim “overlap relief” when the business ends. It is common for businesses to lose track of their overlap relief, which may date from more than 20 years ago.

Larger and more sophisticated businesses tell us the rules are straightforward for them. Many of them take advantage of a feature of the current rules, which makes it possible to defer the payment of income tax by up to a year by choosing an accounting date early in the tax year. However, the great majority of small businesses do not choose this option and select an accounting date in line with the tax year because that is much simpler for them.

The proposed reform will remove the disadvantages and problems associated with overlap relief, and the tax deferral advantages of choosing a particular accounting date: this should help to make the choice of accounting date a purely commercial one.

Example

A business draws up accounts to 30 June every year.

Currently, income tax for 2023 to 2024 would be based on the profits in the business’s accounts for the year ended 30 June 2023. Part of the accounts are outside of the tax year, and part of the tax year is not included in profits taxed.

Our proposed reform would mean the income tax for 2023 to 2024 would be based on:

3/12 of the income for the year ended 30 June 2023, plus 9/12 of the income for the year ended 30 June 24.

1. Introduction

Background and proposals

1.1 “Basis Periods” are a set of tax rules that govern the timing of when income is assessed. Self-employed individuals and partners with trading income use basis periods to allocate trading profits and losses to specific tax years. All entities that use basis periods are collectively termed ‘businesses’ in this document. There is a basis period for each tax year that a business trades in. There are complex rules for basis periods when a business starts and finishes, but over the lifetime of a business, the basis period rules ensure that all profits are taxed once.

1.2 Basis periods are straightforward for the estimated 93% of sole traders and 67% of trading partnerships that draw up their accounts to 5 April or 31 March every year. But if a different accounting date is chosen then the rules are more complex and can be confusing for businesses to understand and apply. The rules can be particularly challenging for new or unrepresented businesses, leading to errors and mistakes in tax returns.

1.3 Choosing an accounting date other than 5 April or 31 March means some profits are taxed twice in the early years of trading as basis periods may overlap. The doubly taxed profits are carried forward as ‘overlap profits’ and deducted when the trade ceases or on a change of accounting date as ‘overlap relief’.

1.4 The basis period rules for trading income are different to the rules for other sources of income such as property and investment income. This can cause confusion, particularly where these other sources of income are included in the same set of business accounts.

1.5 In this consultation we set out a proposal to reform basis periods to move from a current (accounting) year basis to a tax year basis, where the profits or losses for a tax year are those arising in the tax year. The proposed tax year basis would replace all the basis period rules currently in place, removing the special basis period rules for trading income for unincorporated businesses and for the untaxed income of trading partnerships. This would align the basis period rules for trading income with all other forms of income.

1.6 For businesses with an accounting date different to 5 April or 31 March, changing the basis periods to a tax year basis would move the taxation of profits closer to the time when those profits are earned. This paper proposes transitional rules to ease any one-off cash flow impact of the change. All existing overlap relief would be used during this transition period.

1.7 Reform to basis periods is being introduced now as a forerunner and enabler to future reform of the tax system under the wider Tax Administration Framework proposals and as a simplification in advance of the introduction of Making Tax Digital for Income Tax. The government is committed to making it simple to get tax right the first time, and to working with stakeholders to improve the tax system.

2. The current year basis

2.1 Basis periods are the method by which taxable profits or allowable losses are allocated from a business’s accounts to a specific tax year. Basis periods apply to the trading income of unincorporated businesses, such as the self-employed, partners in trading partnerships, and trading trusts and estates. In some cases, the rules apply to other untaxed income of partnerships, and to the trading income of non-resident companies.

2.2 The basis period system uses the ‘current year basis’. This system was introduced alongside Income Tax Self-Assessment in the 1990s, and uses the general rule that the basis period for a tax year is the period of 12 months ending with the accounting date in that tax year (section 198 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA05)). There are additional rules for determining a business’s basis period depending on how many years the business has been trading (sections 199–202 ITTOIA05), and if it changes its accounting date during the year (sections 214–220 ITTOIA05).

2.3 A business’s accounting date is normally the date to which it draws up its accounts, acting as a direct link between a business’s accounts and the profits or losses it makes during a tax year (section 197 ITTOIA05). However, tax law does not require a business to produce accounts, or to produce them to a specific date. Therefore, specific rules exist for defining an accounting date if a business does not draw up accounts during the tax year, or if a business uses one of a range of dates to draw up their accounts each year (sections 201 ITTOIA05, 211–213 ITTOIA05).

2.4 In the first 3 tax years of trading, special rules apply to prevent small amounts of overlap profit from arising. These rules effectively treat accounting dates between 31 March and 5 April as equivalent, as long as the profit falling in the excluded days is included in the next basis period (sections 208–210 ITTOIA05).

2.5 Taken together, these basis period rules mean that there is always a single basis period for each tax year in which a business operates, and these basis periods generally tax at least 12 months’ worth of profits each tax year.

2.6 The rules of the current year basis mean that in certain circumstances basis periods can overlap. The profit arising in the overlap period is then taxed twice, once in the first basis period’s tax year and again in the second basis period’s tax year. To balance this double taxation, corresponding overlap profits are carried forwards by the business. A deduction for these overlap profits is then given when the business changes its accounting date or ceases to trade, to ensure that the profits over the life of the business are only taxed once (sections 204–207 ITTOIA05 and section 220 ITTOIA05).

2.7 The basis period rules can create a significant time lag between the end of the basis period for a tax year and the end of the tax year itself. Any accounting date falling before 5 April creates a lag between the basis period and the tax year, shifting the period over which profits are assessed backwards relative to the tax year. In the extreme case, an individual whose accounting date falls on 6 April will experience a basis period that covers almost none of the tax year that the profits are being allocated to.

2.8 The current year basis is effective in providing certainty and consistency for individuals with trading income. The rules guarantee a basis period for each tax year that the business trades in, and that this basis period will nearly always be at least 12 months long. The connection between a business’s basis period and its period of account under the general rule makes taking figures from accounts and moving them into tax returns more straightforward, as it does not require apportionment.

2.9 However, in ensuring that the current year basis captures all the profits of the business and provides a level of certainty over basis periods, the system has created a complex set of rules and a relief that exists purely for tax purposes. This complexity brings significant downsides for businesses, who find it difficult to understand and apply the basis period rules. The rules on overlap relief are an area of particular complexity, with most eligible businesses not claiming the relief when they should. These businesses may not know they are eligible to use relief, do not know how to calculate relief, or may have lost track of their relief over time.

2.10 This complexity leads to error, failure to engage with basis periods, or use of the relatively simpler 5 April accounting date when another date may make more commercial sense. Evidence shows that many self-employed individuals are making mistakes with basis periods each year. For example, when asked to inform HMRC of their basis period for the tax year on the full tax return, 22% of sole traders do not fill in the boxes in their return. Also, a significant number of traders report overlap relief brought forward despite having a 5 April accounting date, which should be impossible.

2.11 The burden of the basis period rules falls particularly on new businesses in the early years of trading, who have to deal with a specific set of rules for the first three years of trade. Many businesses do not trade for more than 3 years, meaning they may never escape the complex early years of trade rules. The burden also falls on businesses who experience overlap taxation, having their profits taxed twice and waiting many years until they are able to access the corresponding relief. Overlap taxation acts as a direct tax cost in the early years of trade, diverting funds away from business investment and growth.

3. Proposal: The tax year basis

Overview of the proposals

3.1 As set out in the Tax Administration Framework Call for Evidence, the government is interested in exploring how best to reform the basis period system to move from the current year basis to a tax year basis.

3.2 Under this proposal the taxable profits or allowable losses for a tax year would be those arising in the tax year itself.

3.3 The ‘tax year basis’ would replace the ‘current year basis’ entirely, with the tax year basis applying to the trading income of the self-employed, trading partnerships, and in any other cases where the current year basis is used. It would mirror the basis of assessment used in other forms of income, such as property income and miscellaneous income, using similar or identical rules and definitions.

3.4 The ‘tax year basis’ would set the tax year as the basis of assessment, covering profits and losses arising from 6 April to 5 April each tax year. The tax year basis would not mandate a specific accounting date or period of account for businesses. This means that a business’s choice of accounting date would no longer have any impact on its taxation. Businesses would be free to choose any period of account without having to consider the basis period implications, and so would gain greater flexibility in drawing up their accounts for the period that suited them commercially.

3.5 The tax year basis could simplify Making Tax Digital for Income Tax for businesses. Aligning Making Tax Digital quarterly updates for trading income to the tax year would align quarterly reporting for trade and property income, significantly reducing the number of different reporting dates that taxpayers with both forms of income have to consider for Making Tax Digital throughout the year.

3.6 By definition, the ‘tax year basis’ means that overlapping basis periods would be removed from the tax system. This means that profits would no longer be taxed twice at the start of a business, and there would be no new overlap profits generated. This removes the additional tax burden that overlap taxation represents in the early years of trade, and means that businesses will no longer forget to claim overlap relief. Under the tax year basis the profits of a business will always be taxed once over its lifetime, rather than depending on whether a business knows how to claim overlap relief.

3.7 The ‘tax year basis’ also removes the potential for basis periods to cover a significantly different period than the tax year to which they relate. This brings the taxation of profits and the allowance of losses much closer to the time that they are earned or generated, making it easier for businesses to plan their tax payments. The consistency of the tax year basis means that businesses cannot set an accounting date specifically to use the basis period rules to defer the payment of tax on profits. The tax year basis removes this artificial tax advantage that some businesses currently enjoy.

Apportionment

3.8 Businesses with a period of account that did not match the tax year would have to make an apportionment to identify the profit or loss arising in a specific tax year. These apportionments would be carried out in the same way as for other forms of income, such as property income. Profits or losses of periods of account would be split into the parts arising in different tax years, or short periods of account added together to identify the profits arising in the tax year.

3.9 The need to apportion profits to identify those arising in a specific tax year is not an unfamiliar concept as existing basis period rules require apportionments for businesses not accounting to the tax year in the first year of trade. However, apportionment could create a new and recurring administrative burden for businesses with non-tax year accounting dates. Apportionment is a simple, arithmetical process, and for most businesses using tax and accounting software it should be very straightforward. For businesses with fluctuating profits during the year, an alternative method could be used if reasonable and consistently applied.

Estimation of provisional profit

3.10 Businesses that have accounting dates later in the tax year may not have their second set of accounts and tax computations prepared by the filing deadline for the tax year from which to apportion part of their profit. These businesses would normally be expected to use provisional figures to complete their tax return, estimating the amount of taxable profit arising in the final months of the tax year. They would then have to submit an amendment when the information is available to make the final apportionment.

3.11 Informal consultation with a sample of large and small businesses suggests that this issue will affect businesses with accounting dates in the last quarter of the tax year, and may also affect businesses with accounting dates from 30 September onwards, depending on their size and complexity and how quickly it takes to complete their accounts and tax computations. We expect that many affected businesses will choose to change their accounting date to 31 March to avoid this problem. However, this may not be possible or desirable for some businesses, such as seasonal businesses or those with fluctuating profits. Some large international partnerships also draw up their accounts to the same date as their globally affiliated firms and would not want to change this practice.

3.12 Based on self-assessment return data on the spread of business accounting dates, we expect that estimation would affect around 3% of sole traders and 15% of partners.

3.13 For this small proportion of the overall population of taxpayers, the need to estimate their taxable profits for part of the tax year would represent an extra administrative burden. Under current self-assessment rules, businesses would need to submit an estimated return by the 31 January following the end of the tax year, and then make an amendment to it when the final taxable profit for the tax year is known. This would be an additional administrative burden for them, and so alternative approaches to estimation could be explored in order to manage the process. These could include:

• basing estimates on Making Tax Digital quarterly updates
• extrapolation of profits during the ‘known’ part of the tax year
• allowing the final figures to be provided as part of the next tax return

Equivalence of 31 March to 5 April

3.14 As part of the simplification reform, it is proposed that the statutory rule that deems the equivalence of 31 March to 5 April in the first three years of a trade would be extended to apply to all years of trade. This means that businesses that draw up accounts to 31 March would not have to make small apportionments of a few days to determine their profit or loss for the tax year, which they would otherwise have to do.

3.15 We are interested to hear views on whether this equivalence rule ought to extend to property businesses. This would mean that property businesses that draw up accounts to 31 March would also not have to make small apportionments of a few days to calculate their profits or losses for the tax year.

Continuing businesses

3.16 Under the proposed tax year basis, businesses continuing to trade would measure their profits arising over the course of the tax year to identify the taxable profits for that tax year.

3.17 Where a business draws up its accounts for a 12-month period to the end of the tax year, this process is fairly simple, similar to the current year basis. The tax year and the business’s period of account are aligned, so the profit as shown in the accounts can be used as the starting point for profit earned during the tax year.

3.18 The equivalence rule helps to widen this simple method of identifying profits for the tax year. Many businesses choose to draw their accounts up to the end of March, as a way of ending their 12-month period of account at the end of a calendar month. Applying the equivalence rule, which would treat dates from 31 March to 4 April as equivalent to 5 April, a business with a period of account running to 31 March can treat the profit arising in the 12 months to 31 March as the profit arising in the tax year. As long as the days that have been excluded (1 April – 5 April) are included in the next basis period, a small apportionment of 5 days would no longer need to take place.

3.19 Businesses with accounts drawn up to dates not coinciding with the tax year and that do not fall within this 31 March – 5 April window would calculate the profit arising in the tax year by apportioning accounts to identify profit arising in the tax year. It is proposed that this apportionment could be done in the same way as for property income, by reference to the number of days that the periods of account fall in the tax year in question, adding parts of different periods of account together to identify to the profit arising in the tax year. Apportionment by days would be the standard method, but different methods could be used if they were reasonable and consistently applied, following principles already established for property income.

3.20 Some businesses may reach the filing deadline for a tax year without having drawn up accounts covering the entirety of the tax year from which to make apportionments. Following standard practice as part of the Income Tax Self Assessment (ITSA) framework, a provisional figure for the profits covered by the period not covered by accounts could be included in the return. This provisional figure could then be displaced through amending the return when the accounts for the missing period are prepared.

Businesses commencing

3.21 When a business starts to trade under the proposed tax year basis, the standard rule would apply to allocate the profits or losses arising in the tax year to the tax year itself. The basis of assessment in the first tax year would effectively run from the date of commencement to the end of the tax year. This has the same effect as the current year basis rule for the basis period for the first tax year in which a business trades.

3.22 As with any other year, the equivalence rule could apply to the period between 31 March and 5 April. The rule could equally apply to businesses that start trading between 31 March and 5 April, allowing them to shift the few days of trading after they start into the following tax year, so they do not have to return for a few days’ worth of profit or loss.

3.23 The second, third, and following tax years would all see the general tax year basis rules applied to them, without any other specific rules for the early years of trade. This removes some of the most common causes of overlap taxation for businesses, where basis periods in the first, second, and third years of trade overlap.

Businesses ceasing to trade

3.24 For businesses that cease trading during a tax year, the general tax year basis rule would also continue to apply. The profits or losses arising for that trade during the tax year would be those that arise between the start of the tax year and cessation, meaning that no special rules will be needed for the final tax year of trade.

3.25 Businesses that commence trading and cease trading in the same tax year would also be captured by the general tax year basis rule, rather than having a specific provision for their circumstances. In these cases, the profit or loss arising during the tax year will just be the profits that arise between the commencement date and cessation date.

3.26 The only variation that may be required is the application of the equivalence rule for businesses that cease between 31 March and 5 April. As businesses using 31 March would not have another tax year to move the profits of 1–5 April into, if they ceased between these dates they would have to include the profits or losses arising in 1–5 April in the tax year, rather than carry them forward.

Businesses changing accounting date

3.27 The tax year basis removes the link between the date that a business draws its accounts up to and the period over which profits or losses are measured each tax year. Unlike the current year basis rules, if a business changed its accounting date there would be no impact on the timing of taxation. As under the general rule for the tax year basis, to allocate profit to a tax year in which a change of accounting date occurs an apportionment would be made to identify the amount of profit arising in that tax year.

3.28 This removes the distortive timing impact on income tax of a change in the date to which businesses draw up accounts. Businesses would be free to draw up accounts to best suit their own commercial circumstances, and could change this accounting date as their business needs or preferences changed. Although the choice of accounting date would not affect a business’s tax liability, it would still have an impact on administrative burdens. This is due to the need to apportion profits between tax years, unless an accounting date of 31 March or 5 April is chosen.

Partnerships

3.29 Partnerships have a unique set of challenges and issues to be considered when looking at basis period reform, particularly due to the complexity of the current year basis when applied to partners.

3.30 The tax year basis sets all individuals’ basis of assessment to the same period, meaning that the tax year basis in partnership applies to all partners and sets their basis of assessment to the same period. Each partner will still be treated as if they were carrying on a notional trade, but these notional trades will have the tax year basis applied to them, rather than the current year basis. The partnership would be free to set and change its accounting date as it needed, without having to subject partners to the current year basis’ change of accounting date rules.

3.31 Partners that join or leave partnerships would experience the notional trade rules applied to the tax year basis as if the notional trade were any other trade commencing or ceasing. Where an individual joins a partnership and begins their notional trade, the tax year basis immediately aligns the end of their basis of assessment with the rest of the partners in the firm. As the early years of trade rules that exist in the current year basis would no longer apply, partners will no longer have to wait a number of years before their basis of assessment is aligned with other partners in the firm.

3.32 The removal of the current year basis, and alignment of trading income to other forms of income would mean that the specific rules for partnerships with untaxed income and a trade could be removed. There would no longer be a difference in basis of assessment for untaxed income depending on whether the partnership had trading income, and all partnership income would be taxed on a tax year basis. The removal of overlap relief generally would also remove the various forms of overlap relief for untaxed income that arise for partners, and create considerable simplification in working out the tax due to partners each year.

Other issues

3.33 The government is currently exploring and welcomes comment on more detailed areas where basis period reform may interact with other areas of tax. These could include:

• capital allowances
• cash basis
• losses
• other claims and elections
• payment of tax and payments on account
• Double Taxation Relief
• trusts and estates with trading income
• non-resident companies charged to income tax
• averaging of fluctuating profits
• National Insurance Contributions
• student finance repayments
• Tax Credits
• High Income Child Benefit Charge

Other options for reforming basis periods

3.34 Given the complexity of the basis period rules, and the difficulty of finding a suitable “one-size-fits-all” solution, the government has considered other alternatives, set out briefly below.

Mandating the accounting date for tax purposes

3.35 One option would be to make it mandatory for businesses to use 31 March (or 5 April) as their accounting date for tax purposes, as happens in other countries such as the US who mandate a 31 December accounting period.

3.36 Whilst this option would remove overlap profits for new businesses, it would not eliminate the problem of existing overlap relief unless existing businesses were also mandated to align their accounting dates with the tax year. This would be difficult for seasonal businesses and international firms. Aligning all accounting dates for sole traders and partnerships would also generate a difficult annual peak of work for accountants and other professionals such as stock valuers.

A Corporation Tax-like approach

3.37 Another option would be to use a system based on the current rules for corporation tax, where payment and return dates are linked to a business’s accounting date.

3.38 Whilst this option would remove overlap profits for new businesses, overlap relief for existing businesses would not be removed and the current level of errors in claiming relief would continue. Also, this option would require wholescale process and IT changes to the current annual self-assessment system which would be likely to take many years to implement with very significant disruption and cost.

3.39 The government would be interested in views as to the advantages and disadvantages of these options, compared to the proposal of ending overlap relief and moving to an arising basis.

Questions relating to section 3

Question 1:

Do you think that the proposed ‘tax year basis’ for trading income is the best option for simplifying the basis period rules, and the best way to achieve simplicity and fairness between businesses? If not, do you think there is a better option?

Question 2:

Will the proposed tax year basis have an effect on how businesses choose their accounting date, and whether they choose 31 March or 5 April?

Question 3:

For businesses with a non-tax year accounting date, what would be the cost of the additional administrative burden of apportioning profits into tax years? Are there any simpler alternative approaches to apportionment?

Question 4a:

Businesses with accounting dates later in the tax year will have to estimate profits for a proportion of the tax year, before accounts are prepared. For which accounting dates do you think this would be necessary? Do you expect that businesses that have accounting dates earlier in the tax year than 30 September will have to estimate profits? If so, which types of business would be affected?

Question 4b:

Will estimation be a significant burden for those businesses affected, and what will the cost be? Are there any simpler alternative methods of estimating profit or finalising estimates, which could mitigate any extra administrative burden?

Question 5:

Would the proposed equivalence of 31 March to 5 April help businesses that would have to make apportionments to work out their profit or loss under the tax year basis? Would extending this equivalence to property income help property businesses, which would otherwise have to apportion profit or loss each year? Are there any problems with this equivalence proposal?

Question 6:

Are there any specific issues, costs, or benefits to the tax year basis for partners in trading partnerships?

Question 7:

Are there any other issues and interactions to consider for the tax year basis, or the transition, in the areas of tax outlined in paragraph 3.33?

4. Implementation and transition

Timing

4.1 Reforming the complex rules associated with the ‘current year basis’ makes the design and implementation of future reforms to income taxation considerably easier, enabling those reforms and removing some of the complex interactions that may arise between the current year basis and other reforms.

4.2 Aligning the basis of assessment for trading income with other forms of income enables wider, simpler reforms to be considered in the future. In particular, transitioning to the tax year basis in the tax year 2022 to 2023 will simplify the introduction and experience of Making Tax Digital for Income Tax.

Transitional arrangements

4.3 As with any reform, transitional arrangements would be important. A transition to the tax year basis would have no impact for the estimated 93% of sole traders and 67% of partnerships that draw up accounts to 5 April or 31 March. For businesses that have basis periods ending on dates other than 5 April or 31 March, the move to the tax year basis would potentially bring forward tax liabilities.

4.4 For simplicity, the government proposes a one year transition period, with an option to spread any excess profit arising in that transition period over five years. For businesses that do not have a basis period aligned with the tax year, the basis period for the transition year would be determined by adding together two components:

• the standard component, defined by the current year basis for the transition tax year,
• the transition component, running from the end of the basis period for the tax year (the standard component above) to the end of the tax year itself

The transition tax year would introduce the equivalence rule. This means that businesses can treat the end of the tax year for their tax year basis as any date between 31 March and 5 April.

4.5 Alongside this transition, the proposals would mandate that all overlap relief must be claimed in the transition tax year, including any historic transitional overlap relief, or overlap relief generated during the new transition year. No overlap relief would be carried forwards into the new tax year basis, and no new overlap relief would be generated after the transition year.

4.6 Businesses that have a basis period not aligned with the tax year should already have overlap relief brought forward covering the same number of months as the length of the transition component of the transition basis period. This means that the business would not be taxed on more than 12 months’ worth of profits in a single year.

4.7 The exact effect on businesses depends on the difference between the brought forward overlap relief and the additional profits generated in the transition component. Some businesses may experience a reduced tax charge in the transition tax year because of this, but overall, due to the effects of economic growth and inflation we expect the majority of affected businesses to have a greater tax charge in the transition year. Under the current rules, businesses that have a basis period that is not aligned with the tax year would experience a similar acceleration of profit and release of overlap relief either when they ceased trading or on some changes of accounting date. The transition tax year brings all of these accelerations, for all businesses, into the same year, 2022 to 2023.

Mitigating cashflow impacts on transition

4.8 Some businesses may experience higher than normal profits in the transition tax year as a result of the proposals to reform basis periods. This could increase tax liabilities for the transition tax year, leading to cashflow impacts on 31 January following the transition tax year, when the balancing payment for that year is due. To mitigate these cashflow impacts, we are proposing to allow an election to spread any excess profits in the transition year over up to five years.

4.9 This would provide a consistent basis for reducing the cashflow impacts of additional tax bills as a result of the transition for all businesses affected. Businesses would still benefit from the immediate release of overlap relief and the simplification benefits of the reform while being able to smooth the adverse impacts of accelerated profits. However, spreading profits would increase the complexity of the transition, and might require anti-avoidance rules.

4.10 Businesses facing difficulty paying their tax liability in full can also speak to HMRC about agreeing a Time To Pay (TTP) arrangement to spread the payment of tax over time via affordable monthly instalments. TTP would serve as the default option if businesses could not pay in full additional tax due on transition. TTP arrangements are specific to a taxpayer’s circumstances and there is no maximum repayment period. Late payment interest accrues from the due date until the debt is cleared and is factored into the TTP.

Questions relating to section 4

Question 8a:

Does the proposed method of transitioning to the tax year basis using a long basis period combined with allowing all unused overlap relief achieve the best balance between simplicity and fairness? If not, is there a better option for transition?

Question 8b:

Are there any other specific circumstances on transition to the tax year basis that would require additional rules?

Question 9a:

Would the proposals for spreading excess profit mitigate the impact of transition without affecting the simplification of moving to the tax year basis? If not, are there any other ways of mitigating the transition impact that you would suggest?

Question 9b:

Would the proposal to spread excess transitional profits over five years be enough to resolve the cash flow impacts of the proposed reform? Are there any situations which would need additional rules or anti-avoidance provisions?

Question 10:

Are there any other impacts, benefits, or costs in the core policy, transition, or mitigation proposals that we have not considered above?

5. Assessment of impacts

Summary of impacts

Year	2021 - 2022	2022 - 2023	2023 - 2024	2024 - 2025	2025 - 2026
Exchequer impact (£m)

The Exchequer impact will be estimated following consultation, final scope and design of the policy and will be subject to scrutiny by the Office for Budget Responsibility.

Impacts	Comment
Economic impact	This measure is not expected to have any significant macroeconomic impacts.
Impact on individuals, households and families	This measure is expected to have no impact on individuals as it only affects the self-employed and partners with trading income. There is expected to be no impact on family formation, stability or breakdown.
Equalities impacts	Businesses that are expected to be affected by the proposal include farming, other seasonal businesses and large partnerships. Data is not available to determine any particular equalities impacts for those in groups sharing protected characteristics, but it is not anticipated that there will be any. Consultation will provide an opportunity to gain more detailed insight and this will allow for the equalities impacts to be subsequently revised.
Impact on businesses and Civil Society Organisations	This measure is expected to have an impact on all self-employed traders and partners with trading income who do not currently draw up their accounts to 5 April or 31 March. It simplifies the method for allocating trading profit to specific tax years, removing the existing complex basis period rules and replacing them with a much simpler method, taxing profits arising during the tax year. This impact will be explored further as the proposals develop during consultation. One-off costs will include familiarisation with the changes and could also include updating software and guidance to remove the current basis period rules. Continuing costs could include the administrative burden of the cost of estimating profit figures for a small proportion (approx. 3% of sole traders and 15% of partners), and of submitting amended returns to provide final figures after the filing deadline. The measure would also bring forward tax calculations that would otherwise have happened at cessation or on a change of accounting date. For these calculations, associated administrative costs are assumed to be mostly brought forward from future years rather than being additional costs to businesses. Continuing savings could include all sole traders and trading partnerships no longer having to familiarise and apply the basis period rules, not having to notify HMRC on a change of accounting date, and not paying tax twice on the same profit without claiming corresponding relief. They will no longer have to inform HMRC of their basis period or calculate and record overlap relief carried forwards in self-assessment returns. Businesses will no longer risk losing their overlap relief if they mislay their records of it, which may date from many years previously. Customer experience could see an improvement as completing self-assessment returns will be simpler. The consultation will provide an opportunity to test these assumptions with businesses.  This measure is not expected to have an impact on civil society organisations.
Impact on HMRC or other public sector delivery organisations	HMRC will need to make changes to its IT systems to support safe and timely delivery of this policy. There is also likely to be impact on HMRC contact centres in supporting taxpayers adjust to this change. Additional policy resource is also expected to be required to support implementation over the scorecard period, which would be covered as part of business as usual resourcing. Funding will be required to support safe delivery of this measure. Costs are anticipated to be between £15m and £20m to deliver this change.
Other impacts	Other impacts have been considered and none has been identified.

Questions relating to section 5

Question 11

Please tell us if you think there are any other specific impacts on other groups or businesses that we have not considered above.

6. Summary of consultation questions

Section 3. Proposal: The tax year basis

Question 1:

Do you think that the proposed ‘tax year basis’ for trading income is the best option for simplifying the basis period rules, and the best way to achieve simplicity and fairness between businesses? If not, do you think there is a better option?

Question 2:

Will the proposed tax year basis have an effect on how businesses choose their accounting date, and whether they choose 31 March or 5 April?

Question 3:

For businesses with a non-tax year accounting date, what would be the cost of the additional administrative burden of apportioning profits into tax years? Are there any simpler alternative approaches to apportionment?

Question 4a:

Businesses with accounting dates later in the tax year will have to estimate profits for a proportion of the tax year, before accounts are prepared. For which accounting dates do you think this would be necessary? Do you expect that businesses that have accounting dates earlier in the tax year than 30 September will have to estimate profits? If so, which types of business would be affected?

Question 4b:

Will estimation be a significant burden for those businesses affected, and what will the cost be? Are there any simpler alternative methods of estimating profit or finalising estimates, which could mitigate any extra administrative burden?

Question 5:

Would the proposed equivalence of 31 March to 5 April help businesses that would have to make apportionments to work out their profit or loss under the tax year basis? Would extending this equivalence to property income help property businesses, which would otherwise have to apportion profit or loss each year? Are there any problems with this equivalence proposal?

Question 6:

Are there any specific issues, costs, or benefits to the tax year basis for partners in trading partnerships?

Question 7:

Are there any other issues and interactions to consider for the tax year basis, or the transition, in the areas of tax outlined in paragraph 3.33?

Section 4. Implementation and transition

Question 8a:

Does the proposed method of transitioning to the tax year basis using a long basis period combined with allowing all unused overlap relief achieve the best balance between simplicity and fairness? If not, is there a better option for transition?

Question 8b:

Are there any other specific circumstances on transition to the tax year basis that would require additional rules?

Question 9a:

Would the proposals for spreading excess profit mitigate the impact of transition without affecting the simplification of moving to the tax year basis? If not, are there any other ways of mitigating the transition impact that you would suggest?

Question 9b:

Would the proposal to spread excess transitional profits over five years be enough to resolve the cash flow impacts of the proposed reform? Are there any situations which would need additional rules or anti-avoidance provisions?

Question 10:

Are there any other impacts, benefits, or costs in the core policy, transition, or mitigation proposals that we have not considered above?

Section 5. Assessment of impacts

Question 11:

Please tell us if you think there are any other specific impacts on other groups or businesses that we have not considered above.

7. The consultation process

This consultation is being conducted in line with the Tax Consultation Framework. There are 5 stages to tax policy development:

• Stage 1: Setting out objectives and identifying options
• Stage 2: Determining the best option and developing a framework for implementation including detailed policy design
• Stage 3: Drafting legislation to effect the proposed change
• Stage 4: Implementing and monitoring the change
• Stage 5 : Reviewing and evaluating the change

This consultation is taking place at stage 2 and stage 3 of the process. The purpose of the consultation is to seek views on the detailed policy design and a framework for implementation of a specific proposal. Draft legislation on the proposal has been drawn up in order to confirm, as far as possible, that it will achieve the intended policy effect with no unintended effects. However, if changes or additions to the core proposal as a result of this consultation, draft legislation will be updated to reflect those changes.

How to respond

A summary of the questions in this consultation is included in section 6.

Responses should be sent on or before 31 August 2021, by email to [email protected].

Please do not send consultation responses to the Consultation Coordinator.

Paper copies of this document or copies in Welsh and alternative formats (large print, audio and Braille) may be obtained free of charge from the above address. All responses will be acknowledged, but it will not be possible to give substantive replies to individual representations.

When responding please say if you are a business, individual or representative body. In the case of representative bodies please provide information on the number and nature of people you represent.

Confidentiality

HMRC is committed to protecting the privacy and security of your personal information. This privacy notice describes how we collect and use personal information about you in accordance with data protection law, including the UK General Data Protection Regulation (UK GDPR) and the Data Protection Act (DPA) 2018.

Information provided in response to this consultation, including personal information, may be published or disclosed in accordance with the access to information regimes. These are primarily the Freedom of Information Act 2000 (FOIA), the Data Protection Act 2018, UK General Data Protection Regulation (UK GDPR) and the Environmental Information Regulations 2004.

If you want the information that you provide to be treated as confidential, please be aware that, under the FOIA, there is a statutory Code of Practice with which public authorities must comply and which deals with, amongst other things, obligations of confidence. In view of this it would be helpful if you could explain to us why you regard the information you have provided as confidential. If we receive a request for disclosure of the information we will take full account of your explanation, but we cannot give an assurance that confidentiality can be maintained in all circumstances. An automatic confidentiality disclaimer generated by your IT system will not, of itself, be regarded as binding on HM Revenue and Customs.

Consultation Privacy Notice

This notice sets out how we will use your personal data, and your rights. It is made under Articles 13 and/or 14 of the UK General Data Protection Regulation.

Your data

We will process the following personal data:

• name
• email address
• postal address
• phone number
• job title

Purpose

The purpose(s) for which we are processing your personal data is: Consultation on Basis Period Reform.

Legal basis of processing

The legal basis for processing your personal data is that the processing is necessary for the exercise of a function of a government department.

Recipients

Your personal data will be shared by us with (provide details of recipients of the personal data, if applicable for example HM Treasury).

Retention

Your personal data will be kept by us for six years and will then be deleted.

Your rights

• You have the right to request information about how your personal data are processed, and to request a copy of that personal data.
• You have the right to request that any inaccuracies in your personal data are rectified without delay.
• You have the right to request that any incomplete personal data are completed, including by means of a supplementary statement.
• You have the right to request that your personal data are erased if there is no longer a justification for them to be processed.
• You have the right in certain circumstances (for example, where accuracy is contested) to request that the processing of your personal data is restricted.

Complaints

If you consider that your personal data has been misused or mishandled, you may make a complaint to the Information Commissioner, who is an independent regulator. The Information Commissioner can be contacted at:

Information Commissioner’s Office
Wycliffe House
Water Lane
Wilmslow
Cheshire
SK9 5AF
Phone: 0303 123 1113
Email: [email protected]

Any complaint to the Information Commissioner is without prejudice to your right to seek redress through the courts.

Contact details

The data controller for your personal data is HM Revenue and Customs. The contact details for the data controller are:

HMRC
100 Parliament Street
Westminster
London SW1A 2BQ

The contact details for HMRC’s Data Protection Officer are:

The Data Protection Officer
HM Revenue and Customs
14 Westfield Avenue
Stratford, London E20 1HZ
Email: [email protected]

Consultation principles

This consultation is being run in accordance with the government’s Consultation Principles.

If you have any comments or complaints about the consultation process, please submit a comment or complaint about HMRC consultations to the Consultation Coordinator.

Please do not send responses to the consultation to this link.

Annex A: Relevant (current) government legislation

Basis period rules: Chapter 15, Part 2, Income Tax (Trading and Other Income) Act 2005.

Specific basis period rules for partners: Sections 853 to 856, ITTOIA05.

Annex B: Examples of Spreading Adjustments

Examples are under the rules proposed at paragraphs 4.8 and 4.9 of the consultation document, assuming spreading taking place over 5 years, with transition in the year 2022 to 2023.

Example 1:

A sole trader draws up their accounts to 30 April. Their profits for the year ended 30 April 2022 are £55,000, and for the year ended 30 April 2023 £66,000. They have overlap profits brought forward of £20,000.

The profits for the tax year 2022 to 2023 are as follows:

• Current year basis element – year ended 30 April 2022 – 55,000
• Plus transitional element – 1 May 2022 to 5 April 2023 – 66,000 x 11/12 = 60,500
• Less overlap profits (20,000)
• Total profits for tax year 2022 to 2023 = £95,500

These profits exceed the profits under the current year basis by £40,500 (i.e. the transitional element less overlap profits). The sole trader can therefore elect to spread the excess over up to 5 years.

The minimum amount per year to be added is 40,500 / 5 = £8,100. Under this election, assuming the sole trader chooses to add the minimum amount, the profits for the tax year 2022 to 2023 are reduced to 55,000 + 8,100 = £63,100. A minimum adjustment of £8,100 per year will be required to the profits of each of the tax years from 2023 to 2023 onwards (until 2026 to 2023 at the latest) until the £40,500 is extinguished.

Example 2:

A sole trader draws up their accounts to 30 June. Their profits for the year ended 30 June 2022 are £35,000, and for the year ended 30 June 2023 £20,000. They have overlap profits brought forward of £30,000.

The profits for the tax year 2022 to 2023 are as follows:

• Current year basis element – year ended 30 June 2022 – 35,000
• Plus transitional element – 1 July 2022 to 5 April 2023 – 20,000 x 9/12 = 15,000
• Less overlap profits (30,000)
• Total profits for tax year 2022 to 2023 = £20,000

These profits do not exceed the profits under the current year basis, therefore no spreading election can be made.

Example 3:

A partnership with two 50% profit share partners draws up its accounts to 30 September. Its profits for the year ended 30 September 2022 are £130,000, and for the year ended 30 September 2023 £92,000. Partner A has overlap profits brought forward of £40,000. Partner B has overlap profits brought forward of £10,000

The profits for the tax year 2022 to 2023 for Partner A are as follows:

• Current year basis element – year ended 30 September 2022 – 130,000 / 2 = 65,000
• Plus transitional element – 1 October 2022 to 5 April 2023 – (92,000 x 6/12) / 2 = 23,000
• Less overlap profits (40,000)
• Total profits for tax year 2022 to 2023 = £48,000

These profits do not exceed the profits under the current year basis, therefore no spreading election can be made by Partner A.

The profits for the tax year 2022 to 2023 for Partner B are as follows:

• Current year basis element – year ended 30 September 2022 – 130,000 / 2 = 65,000
• Plus transitional element – 1 October 2022 to 5 April 2023 – (92,000 x 6/12) / 2 = 23,000
• Less overlap profits (10,000)
• Total profits for tax year 2022 to 2023 = £78,000

These profits exceed the profits under the current year basis by £13,000. Partner B can therefore elect to spread the excess over up to 5 years.

The minimum amount per year to be added is 13,000 / 5 = £2,600. Under this election, assuming the sole trader chooses to add the minimum amount, the profits for the tax year 2022 to 2023 are reduced to 65,000 + 2,600 = £67,600. A minimum adjustment of £2,600 per year will be required to the profits of each of the tax years from 2023 to 2024 onwards (until 2026 to 2027 at the latest) until the £13,000 is extinguished.