The government is proposing moving from a current (accounting) year basis to a tax year basis for reporting tax on self-employed profits.

Making Tax Digital for Income Tax (MTD for ITSA) is expected to be mandated for the self-employed and business partnerships with annual incomes above £10,000, from April 2023. Before implementing MTD for ITSA, the government intends to simplify the system for allocating trading profit to tax years. It has just issued a consultation which explores which businesses are most likely to be affected. This will include the self-employed, partnerships, trusts and estates with trading income, especially unincorporated businesses that do not draw up annual accounts to 31 March or 5 April.

In summary the government proposes that 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. It would apply to all sole traders and partnerships. The government believes that this reform would remove the disadvantages and problems of overlap relief and the tax deferral advantages of choosing a particular accounting date.”

The consultation document presents this 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
  • the 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.

Stuart Hulland, Partner at Bates Weston comments:

“We welcome the reforms, which should simplify the tax system, particularly for smaller businesses. The current rules surrounding the taxation of self employed and partnership profits date back to the mid 1990’s, which themselves are derived from a system dating back to the 1920’s, meaning they are somewhat outdated. This announcement is another step in HMRC’s directive of making tax digital, with their ultimate aim of taxing profits as soon as they arise”