Assessing partner profits – changes afoot

A guest post by Nicky Owen, professional practices partner at Crowe UK

Owen: The switch to tax-year basis will accelerate tax liabilities

The way in which partnership profits are assessed is set to change with the introduction of Making Tax Digital (MTD), and the intention is that the basis period will change from current-year basis to the tax-year basis from the tax year 2023/24.

The proposed change, which is currently out for consultation, does not just affect partners but encompasses all self-employed individuals and individuals who hold rental properties in their own names or in partnership.

Why change?

Reporting will be easier for individuals when MTD comes in and there will be fewer mistakes made. The change only affects those firms that do not have an accounting year-end of 31 March or 5 April.

What is changing?

The easiest way of understanding what is changing is by comparing the two different bases. If we look at the tax year 2023/24, i.e. the tax year ending 5 April 2024, the personal tax return of each partner will need to be submitted by 31 January 2025.

How are partnership profits currently taxed?

Partners are assessed on their profit share in respect of the accounting year falling in the tax year. For a firm with a 30 April 2023 year-end, the assessable profits associated with that accounting year are taxed in the tax year 2023/24.

There are different rules for new and retiring partners.

What does the new proposal mean?

Under the proposal, partners will be assessed on their profit shares arising in the tax year. For a firm with a 30 April year end that would mean: 25/365 days of the taxable profits for the year ended 30 April 2023 + 340/365 days of the taxable profits for the year ended 30 April 2024.

You may think it will be a bit of hassle splitting the profits, but let’s face it, it’s manageable. But the pressure will be on the firm’s finance teams and their advisers to provide finalised assessable figures for tax returns at a much earlier date.

Where firms usually benefit from foreign tax credits, these are unlikely to be known and will add additional uncertainty to the actual UK tax liability. Those foreign tax credits will need to be updated when finalised figures are available.

How will finance teams manage the work?

If estimated assessable figures are used, then tax returns will need to be amended at a later date and the tax impact managed.

Questions arise around the use of estimated figures – will it give partners false information with regard to their profit shares? How will the firm manage the process and the messaging to partners?

For finance teams and external advisers, workflows will need to be closely managed and controlled with little margin for delay, to ensure that the relevant information is delivered in a timely fashion.

How will firms switch from current year to tax year basis?

The intention is that the tax year 2022/23 will be a transitional year and individual partners will crystallise their overlap profits.

For a firm that maintains a 30 April year-end, the assessable profit for a partner in 2022/23 will be based on:.

  • Assessable profits for the year ended 30 April 2022;
  • 340/365 days of their assessable profits for year ended 30 April 2023;
  • Less overlap profits brought forward.

If the tax liability is higher under the current year basis, then a partner can make a spreading election, for the increase in profit to be spread over five years.

Accelerate tax at the expense of a reduction in working capital tax retentions

Tax reserves held by firms form an important role in providing an element of the working capital in the business.

The switch to tax-year basis will accelerate tax liabilities and firms will therefore need to think about cash flow management and how they will deal with a drain on their tax reserves.

Will there be a need for partners to put additional capital into the business? If so, at what level? Firms will need to start talking to their bankers about the ability to increase their partners’ capital.

Change of accounting date

Firms may reflect and decide to change their accounting year-end date to 31 March, so that life is a little simpler. The consultation period provides time for them to think about how processes will change so that finance teams can manage the workload.

During this time, it is also worth thinking about the potential impact if all firms change their accounting date to 31 March, including the knock-on impact for accountancy firms, which may experience a surge in accounts needing to be prepared and audited in good time to establish taxable profits for the filing of partners’ personal tax returns.

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