In a move poised to redefine the landscape of business taxation, the method for taxing profits of unincorporated businesses has undergone notable changes starting from the 2023/24 tax year, with further adjustments anticipated from 2024/25. This overhaul aims to streamline tax processes in anticipation of the Making Tax Digital for Income Tax Self-Assessment (MTDITSA) initiative, now scheduled to commence its phased rollout in 2026/27.

Traditionally, sole traders and partnership members were taxed based on their share of the business’s profits during its accounting period that ended within the tax year. For instance, under the old system, profits for the year ending 31 December 2022 were taxed within the 2022/23 tax year. However, with the introduction of new regulations, the assessment period for the 2024/25 tax year will span profits generated from 6 April 2024 to 5 April 2025. This period combines nine months of profits for the year ending 31 December 2024 and three months from the year ending 31 December 2025. Given the filing deadline of 31 January 2026 for the 2024/25 self-assessment tax return, many businesses will likely need to estimate the latter period’s profits, subject to later adjustments.

This complexity has prompted a shift among many businesses towards aligning their accounting year-end with the tax year, specifically to 31 March or 5 April. Such alignment simplifies the tax filing process and mitigates the need for profit estimations, paving the way for a more straightforward assessment under the new tax regime. This adjustment represents a significant departure from traditional practices, setting a new standard for tax reporting and compliance for unincorporated entities.

A further complication with the change in the basis of assessment is the calculation of profits in 2023/24, the “transitional year”, which seeks to transition from the old ‘current year’ basis to the new tax year basis. The rules in 2023/24, where the business has a year-end that doesn’t correspond with the tax year, seek to tax the profits from the day after the end of the period taxed in 2022/23 until 5 April 2024.

A business preparing accounts to 31 December each year would have a 15-month period from 1 January 2023 to 5 April 2024 potentially taxable in 2023/24. However, the 3 months’ profits in the period 1 January 2024 to 5 April 2024, less any overlap relief, is not all taxed in 2023/24 but spread over 5 years, unless the taxpayer elects to be taxed on a higher amount.

If, in the above example, the sole trader makes profits of £120,000 in year ended 31 December 2024 then £30,000 less any overlap relief (typically from the early years when some profits were taxed twice) would be spread over 5 years. Assuming no overlap relief, an extra £6,000 profits would be added to the profits assessable from 2023/24 to 2027/28 unless the individual elects to be assessed on a higher amount, in which case the balance of the £30,000 would then be spread over the remaining years to 2027/28. We appreciate that this can be complicated, and our team can work with you to calculate the transitional profits and advise you of your tax liabilities going forward.