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Income tax basis period reform consultation – Law Society response
HM Revenue and Customs (HMRC) was seeking views on implementation of a proposal to change the rules under which profits of an unincorporated trading business are allocated to tax years.
HMRC is proposing changes to the way that trading profits – including profits of the solicitors' profession – are allocated to tax years for tax purposes.
This is referred to as ‘basis period’ reform and it affects income tax for the self-employed, including partners in partnerships and limited liability partnerships (LLPs).
The proposals are therefore relevant to:
- law firms that are sole practices, partnerships or LLPs
- freelance solicitors
The proposals are not relevant to companies.
Broadly speaking, under the current basis period rules, profits are allocated from the accounts of an ongoing business to the tax year in which the business' accounting period ends.
The proposals would change that so that profits of the business that 'arise' in each tax year would be allocated to that tax year.
In our response, we seek to explain the nature and extent of the expected impacts of the proposals on members:
- the proposals will result in material tax liabilities being brought forward in the transitional year (proposed to be 2022/23 and subject to a five-year spreading option) for many firms, which will affect cash flow and funding requirements
- they will also create significant compliance complications, including challenges in meeting tighter tax filing deadlines. Some partners will have to file tax returns on a provisional basis with later corrections required
- there will be consequent pressure on law firms’ tax teams and on accountants who prepare tax computations
- these issues are compounded by the short transition timeline
We believe that:
- a coherent plan should be set out that recognises the various interlocking initiatives of relevance to these proposals
- commencement of the proposals should be pushed back by at least two years to allow more time for consultation and preparation
- several specific changes should be made to the proposed transitional provisions to allow for greater flexibility, reduce potential unintended consequences, and ease the cash-flow impacts of the proposals
- administrative simplifications should be introduced to ease the burdens identified; alterations to tax return filing deadlines should be examined to allow fair time for the tax compliance process to be achieved
We’re keen to engage further and to ensure a workable regime.
We think that additional consultation and discussion is required beyond this short consultation window.
What this means for solicitors
These impacts arise in part as a result of specific features of the legal sector.
One of those features is the prevalence of the partnership model. The vast majority of the largest law firms are LLPs or general partnerships.
Both partnerships and LLPs are transparent for UK tax purposes: that means these proposals will apply to them because their trading profits are charged to income tax in the hands of the partners or members.
Another important feature of the UK legal sector is its international dimension.
These proposals will give rise to several specific issues for international law firms headquartered or operating in the UK, including:
- constraints in relation to selecting their accounting date
- potential additional complexity in relation to profit allocation, overlap relief and double taxation relief
The consultation closed on 31 August.
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.