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It was reported in the Financial Times that “Half a million law partners and sole traders face bigger tax bills next year”.

Whilst the article was aimed at law firms this is likely to affect all individuals who are self-employed, including members of partnerships and LLP’s who currently have accounting years which are not the same as the tax year.

What’s changed?

The change was one of the legislation day announcements released by HRMC on 20th July this year. The proposal is that all non-incorporated businesses will need to pay tax based on the ‘tax year’ rather than the ‘accounting year’ with effect from 2022/23 year.

What this means in practice is that for anyone who currently submits their tax returns based on accounts ending on a date other than the 31st March or 5th April, they will end up paying tax on their profits earlier than they have been doing. Many large partnerships prepare their accounts to the 30th April each year, so this change will bring forward the date of payment of tax on 11 months’ worth of profits.

There is currently a rather complicated method of assessing profits of unincorporated businesses in the opening and closing years of those businesses. In theory this should even out the effect of any change in the basis of assessment such as the one currently being proposed.

Impact on cash flow

However, in practice, where profits are continually rising there will be a significant impact on many businesses when this proposed change is bought in in 2022/23. Whilst ultimately this will only be a cash flow issue, as we all know, cash flow is king and such a cash flow shock could cause significant problems for some businesses.

The changes will also complicate matters for businesses who continue to run their accounting years to years other than the tax year. This is because the tax assessment will be based on a fraction of more than one year. For example, a business with an accounting year to the 30th April, will now need two sets of accounts to be prepare and finalised in order to complete their tax return. For the 2022/23 year their tax assessment will be based on 1 month of the year to April 2022 and 11 months of the year to April 2023. For this reason, many larger partnerships are considering whether it will be appropriate to change their accounting year to make it coterminous with the tax year end.

Bringing forward tax payment dates

This change of basis is being sold by HMRC to the public as a simplification as it does away with the necessity for the complicated opening and closing year rules. It also makes things simpler for the drive towards making tax digital, but the move towards bringing forward tax payment dates in general is part of an ongoing process. We have already seen the change to the taxation of capital gains on disposals of property which is now payable with 30 days of a sale rather than 10 months after the end of the tax year.

I anticipate we will see more moves in future from HMRC to bring forward tax payment dates to closer align payment with the receipt of income. In the meantime I encourage anyone with an unincorporated business and the year end which is not already aligned with the tax year to contact their accountants to discuss the potential impact of these proposed changes.

Losses

If profits of the partnership are now lower than they were in the early days of the business then it is possible that the change of basis period will result in the partner having partnership losses. Use of losses, and restrictions on the use of losses, is explored in the blog on partnership loss planning on that subject.

Over recent weeks I have heard increasing noises about the death of the Limited Liability Partnership (LLP). The commentators highlight factors such as the higher rates of income tax and the frequency by which partnerships have converted to companies. The legal profession is often cited as a further reason for the demise of LLPs. The alternative business structures (ABS) in which lawyers can now operate, permit legal firms to transact through the medium of a company. This has aided the expansion of quoted law firms and has facilitated incorporation of law firms which previously were partnerships.

Even as recently as 25 October 2013, HMRC issued tax legislation that detracts from professional practices operating as partnerships. Prior to that there has been discussion about HMRC taxing partners in partnerships as if they are employees. All of this suggests that the direction of travel is away from LLPs and into companies. Incorporation of partnerships can lead to tax planning where the partners extract value out of the partnership at a rate of 10%. There have been many tax-driven incorporations which use this technology.

Despite this I am not so pessimistic about the demise of LLPs. They are well understood and commonly used vehicles in areas other than professional practices. Even in professional practices they have one very substantial tax advantage over private companies. When it comes to succession, partners can be brought through the ranks without a tax cost. Bringing in the next generation of shareholder in a company can be very difficult to implement unless the individual included is willing to suffer a tax cost. Another benefit of partnerships is that Partnership Agreements can allocate partners rights to income and rights to asset ownership in different proportions. This flexibility is difficult to match in a company.

Finally, a non-tax reason which suggests the continued existence of an LLP is the partnership ethos. The thought that “we are all in it together” helps prevent dysfunctional behaviour that can be found in more structured, corporate, environments.

As a tax practitioner with a client base including many partnerships I do not see the demise of the LLP and am looking forward to a long and fruitful career advising them.