Government proposes 'simplified tax reporting' for small businesses but could it add more costs?

The government has proposed changes to tax reporting rules which it says will speed up the time it takes the self-employed and small business owners to complete tax returns and prevent thousands of errors.

The changes to so-called basis periods, which would come into force by 2023, would mean unincorporated businesses being taxed on profits arising in a tax year, rather than profits on accounts ending in the tax year.

A basis period is the time period used by sole traders and partnerships for when they pay tax each year. The majority of companies align that period with the 5 April - 6 April tax year, but some firms, such as seasonal businesses, choose different accounting dates.

Tax returns are currently worked out from a business' set of accounts up until the end of the tax year. That means companies with an accounting period that doesn't match the tax year could be taxed twice due to having overlapping basis periods. A company's first year of trading is taxed on the period to the end of the tax year, with subsequent years based on their full accounting year.

The rules are particularly challenging for new businesses because they often have an accounting period different to the tax year.

The government's consultation document for the proposed reform says 7% of sole traders do not have "straightforward" accounting dates, which means around 350,000 could currently be affected.

The rules are so complex that thousands of businesses make mistakes on their tax returns. Founders can claim tax relief on over-payments but more than half of those entitled to receive the relief do not apply for it.

Proposed changes to basis periods

As part of its Making Tax Digital (MTD) plan to simplify the tax system, the government is proposing that all businesses be taxed on profits in the tax year, rather than profits on accounts ending in the tax year. This would mirror how other forms of income, such as property income, are assessed.

The government provided the following example to explain the change:

• A business draws up accounts to 30 June every year.

• Currently, income tax for 2023/24 would be based on the profits in the business’s accounts for the year ended 30 June 2023.

• The proposed reform would mean the income tax for 2023/24 would be based on: 3/12 of the income for the year ending 30 June 2023, plus 9/12 of the income for the year ending June 2024.

Impact on businesses of the basis period changes

In the consultation document, the government estimates that around 3% of sole traders and 15% of partners would face an extra administrative cost as a result of the changes. 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.

The consultation is due to end on 31 August but the Association of Taxation Technicians (ATT) called for the deadline to be extended and the introduction of the reform to be delayed for a year. The group said it fears advisers to affected businesses don't have time to provide sufficient feedback to the government and "the pace of change may overwhelm many businesses".

The ATT's Jon Stride said: "The proposal to tax businesses on profits arising in the tax year itself is sensible and will eventually simplify matters for unincorporated businesses. We also support bringing in the change in advance of the introduction of MTD for Income Tax.

"But it is vital that the design and implementation is fully considered and not rushed if it is going to work for businesses and the government. Given all the current upheaval for businesses, both this change and the MTD roll-out should each be delayed by a year."

Pete Miller, from the Chartered Institute of Taxation, expressed similar concerns.

"This is a welcome simplification of the current system which has been with us in one shape or form since the 1920s, but we are concerned about the speed at which it is being introduced and whether there will be enough time for businesses to absorb the impact of the change on their individual circumstances and take action to avoid any adverse or unforeseen consequences," he said.

"We are also concerned that the government consultation on this reform is inadequate. Six weeks during the holiday season, in the middle of a pandemic, is not sufficient for tax professionals and others to assess the detail of this significant change, how it will affect them and their clients, and provide constructive feedback to government on it."

To respond to the consultation on the basis period reforms, read this document and send your views to businessprofits.admin@hmrc.gov.uk by 31 August.

To share your views with Enterprise Nation, email hello@enterprisenation.com.

Useful resources:

• Watch a webinar sharing five tips for a smooth tax return.

• Ask questions in the accountancy and taxation group.

• Need help with your accounts? Find an adviser.