HMRC has caused a major headache for 500,000 freelancers – here’s how not to be caught out

As the Telegraph recently highlighted, a major change is coming for over half a million sole traders and partnerships. The new rules will apply for the 2024-25 tax year with 2023-24 designated as a transitional period.

What’s happening?

The position for sole traders and partnerships until now has been that your profits assessed for tax each tax year are based on the accounts ending in that tax year. So if you produce your accounts to Dec 31 you will have reported your results to Dec 31, 2022 in your 2022-23 self-assessment.

From next April this changes to basing tax on the amounts earned across the tax year concerned. If you keep to a Dec 31 year end, for example, in tax year 2024-25 your self-assessment will be based on 270/365 of your December 2024 accounts plus 95/365 of your December 2025 accounts.

Why is the change happening?

The Government says that this has to happen as part of the move towards “making tax digital”. They say that the change will make reporting profits “simpler, fairer and more transparent”. Others, including the Association of Taxation Technicians, disagree. It is concerned that it will create a major complication for those affected and that businesses caught are likely to pay increased amounts of tax.

Will it affect me?

It will catch all sole traders and partners in trading partnerships who do not currently have their accounting year ending on March 31, April 5 or the days in between.

Should I change my accounting date to March 31 or April 5?

You are not obliged to do so but it would probably make life easier in the long run if you did. One problem is that the self-assessment filing deadline remains at Jan 31. Taking the example above you would only have one month after Dec 31 to prepare accounts before the deadline. HMRC will accept provisional numbers but these will then have to be estimated and then corrected.

Will my accountant be able to cope?

With difficulty I suspect. Writing as a retired accountant I am concerned for those in practice having to manage this change. January is already the busiest month for self-assessment so the thought of having to push more work into this time with provisional numbers required sounds horrific. 

On the other hand, if everybody moved to a March year end that would increase pressure over the summer months. I accept that this change is not being made to improve the social life of accountants but their clients may have to put up with longer delays in dealing with their annual accounts and will probably have to pay extra costs.

How tolerant will HMRC be during the change?

We are waiting for more guidance but HMRC knows that adjustments will be required to working practices. In particular we understand that there will be a relaxation in the rule that amendments to self-assessment returns have to be made “without delay” and that normal amendment time limits will apply. Hopefully this means that for 2024-25 we will have until Jan 31, 2027 to correct provisional figures

How does the 2023-24 transitional year work?

For those affected, the tax for this year will be calculated using two component parts:

1. the standard part that would normally follow from the accounts ending in this tax year, plus
2. the transitional part running from your year end to April 5, 2024, less brought forward overlap relief (see below for explanation). This is the excess profit.

What is overlap relief?

When a business starts it is taxed in the first year on the profits up to April 5. The second year is assessed on the first 12 months of trading. This means that some profits are taxed twice. Suppose you started trading on 1 July 2016 and ran your accounts to June 30, 2017. The nine months to April 5, 2017 will have been subject to tax twice. This amount is called your overlap profit and is the amount available for overlap relief in the calculation above.

For many traders this will result in higher tax. This is because profit in the transitional part above is likely to be more than the overlap relief. This year is the last time overlap relief is available.

What can I do about tax on the excess profit?

You cannot reduce the amount but the excess profit will be spread and taxed over five years.

Are there any other complications?

Complications will arise if you make a loss. There may also be issues for those with student loan repayments or with personal allowances being tapered for income above £100,000. 

However, we understand that the rules will prevent anomalies arising with Universal Credit, Tax Credits and the High Income Child Benefit Charge. Detailed guidance is available here.