Small firms

How changes to accounting dates could lead to higher tax bills

Andy Poole, from Law Society partner Armstrong Watson, explains how the proposed basis period reform could lead to higher tax bills for law firms.

Following the launch of a consultation by the government, law firms could see significant changes to the way they are taxed. This may result in some facing higher tax bills than expected.

HM Revenue & Customs (HMRC) claims that the proposed ‘basis period reform’ will simplify rules where accounting profits of sole traders, partnerships and LLPs are allocated to tax years using basis periods. It is then aiming to streamline the system before Making Tax Digital (MTD) is fully implemented.

If implemented, the new rules will be fully introduced from April 2023, with the tax year starting 6 April 2022 as a transitional year.

This is a short timescale, and accountancy bodies are already lobbying the government for a delay to allow businesses and accountants to get to grips with these changes.

The current situation

Sole traders, partnerships and LLPs are currently taxed on their accounts ending in the tax year, and a business can choose any date to prepare accounts for.

Some businesses have kept the same accounting date they have had for many years, while others have an accounting date that ties in with busier or quieter periods; either to maximise annual results or make year-end procedures easier.

HMRC’s preference is for everybody to prepare accounts to 31 March each year to tie into the tax years that end on 5 April.

The basis period reform

The reform would mean law firms would be taxed on profits arising in a tax year and is intended to align the way self-employed profits are taxed with other forms of income, such as rents received or investment income.

For example, under the current rules, a law firm with a year end of 30 June 2021 would be taxed on these profits in the tax year to 5 April 2022, but under the proposed changes, nine of the 12 months of the profits would be taxed in the previous tax year to 5 April 2021.

Firms that retain their traditional accounting date

For a firm that retains its traditional accounting date, the taxable profit to enter on the tax return will be made up of apportionments from two sets of accounts, making it difficult to see how this can be described as a simplification.

Firms that decide to move their accounting date to 31 March

For a firm that decides to move its accounting date to 31 March, there is a transitional adjustment in the tax year ending 5 April 2023.

Firms that have had their current accounting date for a long time

Firms that have had their current accounting date for a long time, or which have significantly increased their profits since commencement, could face an unexpected increased tax bill.

However, we understand that there is likely to be the facility to spread this additional tax charge over five years.

The driving force and implications

HMRC says the new system aims to reduce the time spent by small businesses filing their tax returns, and to make the rules fairer, more logical and easier to understand.

However, it appears that the driving force behind this change is to assist with the introduction of MTD for non-company businesses from April 2023. This will involve the completion of a quarterly submission of data to HMRC.

Whilst these changes may simplify matters for small businesses not using an accountant, they are likely to increase complexity and accelerate tax bills for many law firms. Not least when there are changes of partners on an accounting year-end date that does not tie into the end of a tax year.

The consultation period is short, and the proposed start date for transition is April 2022. This suggests that HMRC will be pushing ahead with this to ensure that quarterly reporting under MTD in April 2023 can be introduced on time, as planned.

Next steps

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The consultation has now closed. Once the changes have been confirmed, we will be reaching out to our law firm clients to help them to assess the impact for each firm.

Find out more about Armstrong Watson

Your firm can prepare by calculating what the tax would be if you were to change your year end to 31 March.

The calculations will need to be done by a partner, and so it may be easier for firms to contact their accountants to ask them to do this.

Once the impact is assessed, firms may then be able to judge how they can make any necessary payments.

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