Basis period reform – law firm partnerships and LLPs

Subscribe

The legal sector is set to be heavily affected by the basis period reform which impacts self-employed partners in both standard partnerships and LLPs. As an industry in which these business structures are common, consideration needs to be given as to how the changes will impact both the individuals and the business.

From the 2024/25 tax year, all business profits subject to income tax will be assessed on the profits arising in the tax year, no matter when their accounts are drawn up. The intention is to help simplify individuals tax affairs, however in order to transition to the new regime HMRC has implemented various rules.

Firms with an accounting year end that does not follow the tax year will be subject to transitional rules which may have quite an impact on their tax position. Depending on when your current accounting year end falls, it may be beneficial to consider aligning it with the tax year.

Transitional year 2023/ 2024

For the 2023/24 transitional year, the following applies for ongoing businesses:

• The ‘standard’ part – the normal accounting period; plus
• The ‘transition’ part – from the end of the ‘standard’ part to 5 April 2024; less
• Overlap profits brought forward. These profits have to be offset and there is no option to elect to carry these forwards. From 2023/24 there will no longer be overlap profits created.
• Transitional profits – the ‘transition’ part less overlap, can be spread equally over five years starting with 2023/24 and finishing with 2027/28
• An election can be made to accelerate all or part of these transition profits. Each partner can make their own election, and so must review the impact on their own affairs to ensure that they are being assessed in the most beneficial way.
• If the business ceases to trade before the start of the fifth year, (or when a partner resigns or retires from a partnership), the balance of the profits will be treated as arising in the tax year of cessation.
• Where overlap profits exceed the ‘transition’ part, the resulting loss can be treated as a ‘terminal’ loss – set against the profits of the same trade for the previous three tax years, with the latest first.

Implications of tax payments

The reforms will accelerate tax payments for many individuals. It may also push individuals into higher tax rate bands particularly where a business ceases before the fifth year or a individuals chooses to retire or leave the business, something partners considering retirement must factor in.

It may be more beneficial for partners to bring forward elements of the transitional profits to ensure they are being taxed at the most beneficial rates. The profits can be accelerated unequally if preferred, the only rule being that at least an amount equal to the transitional segment must be assessed. Once the total of the transition profits have been assessed, that is it –  a partner can clear the balance prior to the final 2027/28 year if they elect the standard five splits.

Future considerations

Going forward, businesses that do not currently draw accounts to the end of the tax year or 31 March (having assessed a change in year end as not being a suitable option for them) will have a much shorter period to finalise their figures. For example, those drawing accounts to 30 April currently have 22 months before the self-assessment filing deadline whereas in future, they will have 9 months. Partners will need to ensure that they have reserves in place to cover their tax liabilities as the time between the tax being confirmed and being due to be paid will be far tighter.

Individual partners should consider taking expert advice to help ensure they understand the real impact of these changes on their personal tax affairs and to allow them to manage the immediate cash-flow impact of the changes.