In mathematics, the change of basis is a:
“technique that allows us to express vector coordinates with respect to a “new basis” that is different from the “old basis” originally employed to compute coordinates.”
Mercifully, this is not a maths/math article. This article is a UK tax one though, about a topic which tax professionals know well but managers establishing their new business as an LLP can often find even more confusing.
Right here, right now
Under existing UK law, the individual member(s) of an LLP (along with other partnerships and sole traders) are taxed on the “current year” basis. In essence, this means that the profits assessed in a UK tax year (from 6 April to the 5 April in the following calendar year) are those for the accounting period ending in that/the current year.
For example, an individual member of an LLP that has a 31 December 2021 year-end will be assessed on their share of the partnership’s taxable profits (in respect of that accounting period) in the tax year ended 5 April 2022 or “2021/22”. The income tax and National Insurance contributions (“NICs”) due thereon should ideally be paid in full by 31 January 2023.
So far, a little quirky, but easy enough to follow. For new individual members of partnerships, however, things get a little more complicated as a result of something called the “opening year rules”. Without summarising these rules in full, these can look:
- First tax year: to the adjusted profits from commencement/joining to the immediately following 5 April
- Second tax year: to the adjusted profits of the accounting period ending in the second tax year, if these relate to a period of 12 months or more in length.
As this is the point when new individual members of an LLP can start to get a little lost, and matters only get worse when the concept of “overlap profits” arises, let’s use an example:
Darcey is an individual member of UK Asset Management LLP. Darcey joined on January 1, 2021 (as the LLP has a December accounting year-end). Darcey is not considered a Salaried Member of the LLP and her share of taxable profits to 31 December 2021 was £215,000. In the year to 31 December 2022, Darcey’s share of the LLP’s taxable profits will be £250,000.
The UK’s current tax rules allocate Darcey’s profit shares as follows:
- Tax year 2020/21: the profits from 1 January 2021 to the following 5 April. If simple time-apportionment is used this will result in taxable income for the year of circa £55,960
- Tax year 2021/22: the question is asked whether there’s an accounting period ending in the year and, if so, whether it is at least 12 months after Darcey commenced as an individual member? As financial statements are prepared to 31 December 2021, and Darcey joined 12 months before, the answer to both is yes. Darcey is therefore taxed in 2021/22 in respect of £215,000.
- Tax year 2022/23: by now the current year basis can apply, and Darcey is taxed on the accounting period ending in the tax year (and so £250,000).
All straightforward then? Well, no, as those still following will have realised that after two profit shares and three UK tax years, Darcey has been subject to income tax and NICs in respect of:
- 2020/21 £55,960
- 2021/22 £215,000
- 2022/23 £250,000
- Total £520,960
Darcey has in effect been taxed on £55,960 twice (in 2020/21 and 2021/22). These are overlap profits. Circa 3 months’ worth.
The overlap profits will (if claimed) be carried forward to be relieved (at whatever UK income tax rate is then in force) either when Darcey ceases to be a member of UK Asset Management LLP or the partnership changes its accounting date in certain circumstances.
What is changing?
From 6 April 2024 individual LLP members will be assessed on their profits for each tax year (i.e., 6 April to following 5 April). So, best part of 18 months away, and so no need to read on? Well, no. The next tax year (starting 6 April 2023) will be a transitional year. As a result, in 2023/24, an individual member will be assessed on adjusted profits for the:
A. 12 months’ accounting period previously used; and
B. rest of the 2023/2024 tax year
The transitional year will allow those (like Darcey, in the example above) to relieve historic overlap profits (ordinarily) against the amount calculated under B. above. Any excess of profits under B. (after deducting overlap relief) can be spread over the next (up to) 5 tax years. Special rules exist where the overlap relief creates or contributes to a loss.
Who is not affected?
If the LLP’s accounting date is already between 31 March and 5 April then this change will have no impact (assuming all overlap relief was previously correctly claimed on any prior change of accounting date).
What to do now?
While the first affected income tax return (in respect of 2023/24) is not due for filing until (if filed online) 31 January 2025, the potential impact of these changes should be considered sooner.
For example, an individual LLP member’s tax return (for 2021/22, due for filing (at the latest) in less than 2 months) should show any overlap profits carried forward to ensure this number:
- continues to be carried forward, and so not forgotten (when calculating profits for a tax return due for filing circa 2 years from now)
- is readily accessible for the 2023/24 filings, when the time comes.
As HMRC note at Business Income Manual 81270:
“Under the new tax year basis rules, overlap relief cannot be deducted and all unused overlap relief will be lost at the end of the 2023/24 tax year”
Any individual who:
- joined a partnership with a non-31 March to 5 April year-end (typically November or December, for alternative asset managers) and
- was allocated profits (e.g., not losses) in the opening years of their being a partner
will have overlap profits. If these are not shown on the self-assessment tax return in 2021/22 then, unless these have been utilised on a previous change of accounting date, the question should be asked as to why. While HMRC is continuing to explore methods of sharing the figures they have, taxpayers should not rely solely on this as a means of establishing the correct amounts. Any inquest to establish why such amounts aren’t showing on a partner’s personal return at all should be opened now.
As noted above, from UK tax year 2024/2025 (and future years) where financial statements are prepared to a date other than the tax year-end, taxable profits will be calculated by apportioning the profits for the two accounting periods that straddle the tax year. UK LLPs may therefore consider changing their accounting date to avoid the:
- administrative aggravation of apportionment
- confusion apportionment might cause to individual members, who, once through the initial fog of the opening year rules, have grown to understand the current system.
Taking 2024/25 as example, in terms of apportionment, a longstanding individual member of a UK LLP with a 31 December year will have to include profits from:
- 6 April 2014 to 31 December 2024, and
- 1 January 2025 to 5 April 2025
in their return for the year ending 5 April 2024. This return will be due by 31 January 2026, by which time the audited financial statements to 31 December 2025 are unlikely to be finalised. As HMRC notes:
“From 2023 to 2024 onwards, some businesses might have to use provisional figures on their returns.”
While this will become more common (as HMRC expands Making Tax Digital for income tax), it could be avoided with a change of accounting date.
A business does not have to change accounting date, however, and the:
- pain of apportionment can be diminished by working with experienced third-parties
- timing of such a change needs to be considered, as those wanting to change year-end in 2022/23 (i.e., the year before the transitional year) will still have to apply existing rules determining whether such a change is valid for UK tax purposes anyway. The restrictions on changing one’s accounting date that are currently in place will be removed from 2023/2024
- thought of moving away from a December year-end, for example, will likely not be appealing to US headquartered businesses in particular having to consolidate UK subsidiaries.
If you have any questions regarding the topics discussed in this article, please do not hesitate to get in touch.