Potentially the biggest change in partnership tax for decades

In advance of the planned move to Making Tax Digital (MTD) for income from 6 April 2023, HM Revenue and Customs have launched a consultation on basis period reform, which is open for responses until 31 August 2021. Draft legislation has been published, which, if enacted, would have a significant impact on the tax position for sole practitioners as well as members and partners in professional firms.

Current partnership tax

Currently, taxes for partners are assessed on the partnership’s accounting year ending during a tax year. For example, a year end of 30 April 2021 or 31 December 2021 would each form the basis period for the tax year ending 5 April 2022. There are also special rules covering the first three years of trading and on cessation.  Where the accounting year end is not matched to the tax year, this leads to income being assessed twice in the opening years. Relief can be claimed on this double assessed income on cessation; this is known as overlap relief.

New tax rules

While MTD may appear some distance away, transitional rules as currently drafted would reduce complexity of the current basis period rules, but would have a significant impact on income reporting from next year.

Using a 31 December year end as an example, the income that would be reportable in the 2022/23 tax year would include the following three parts:

• profit share from 1 January 2022 to 31 December 2022 (as is the case under current rules); plus
• profit share from 1 January 2023 to 5 April 2023 (based on a pro-rata share of the profits for the year ending 31 December 2023);
• less overlap relief brought forward.

Where the assessable income is greater than the figure under the first bullet point, an election can be made to spread the excess income over five tax years to mitigate adverse tax consequences. HMRC may also introduce anti-avoidance rules if they consider the rules are being manipulated.

The filing deadline for the 2022/2023 tax return is 31 January 2024, and it is likely that taxable profit and profit shares for the accounting period ending 31 December 2023 will not be available by this time. In this situation, it is envisaged that estimates could be used and corrected once final numbers become available. The final rules have not been decided and details will be finalised once the consultation has completed.

After 6 April 2023, profits will be assessed on a tax year basis irrespective of the year end of the business accounts. In the face of this, consideration should be given to the benefits of changing the accounting date to 31 March.

This could have far reaching cashflow implications accelerating the tax for many professional partnerships and hitting the cashflow of the sector. Early analysis of how you are affected is strongly recommended.

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