In mathematics, change of basis is a technique that allows vector coordinates to be expressed with respect to a new basis rather than the one originally used.
Mercifully, this is not a maths article. It is a UK tax article on a topic familiar to tax professionals but often confusing for managers establishing new LLP businesses.
Right here, right now
Under existing UK law, individual LLP members (along with other partnerships and sole traders) are taxed on the current-year basis. In essence, profits assessed in a UK tax year (6 April to the following 5 April) are those for the accounting period ending in that tax year.
For example, an individual member of an LLP with a 31 December 2021 year-end is assessed on their share of partnership taxable profits for that accounting period in the year ended 5 April 2022 (2021/22). The related income tax and NICs should ideally be paid in full by 31 January 2023.
For new individual members, matters become more complex because of the opening-year rules. Broadly, these can apply as follows:
- First tax year: adjusted profits from commencement/joining to the following 5 April.
- Second tax year: adjusted profits of the accounting period ending in the second tax year, if that period is at least 12 months.
This can create overlap profits, so an example is useful.
Example 1
Darcey joins UK Asset Management LLP on 1 January 2021 (31 December year-end). She is not a salaried member. Her share of taxable profits is GBP215,000 to 31 December 2021 and GBP250,000 to 31 December 2022.
Under current rules, Darcey's profit shares are taxed broadly as follows:
- 2020/21: profits from 1 January 2021 to 5 April 2021 (circa GBP55,960 on simple time apportionment).
- 2021/22: profits for year ended 31 December 2021 (GBP215,000).
- 2022/23: profits for year ended 31 December 2022 (GBP250,000).
Across three UK tax years, this gives taxable amounts of GBP55,960, GBP215,000 and GBP250,000 (total GBP520,960), meaning GBP55,960 has effectively been taxed twice. Those are overlap profits.
Overlap profits can generally be carried forward and relieved (if claimed) when the individual ceases to be a member or the partnership changes accounting date in certain circumstances.
What is changing?
From 6 April 2024, individual LLP members will be assessed on profits arising in each tax year. The tax year starting 6 April 2023 is transitional.
In 2023/24, an individual member is assessed on adjusted profits for:
- A. the 12-month accounting period previously used, and
- B. the remainder of the 2023/24 tax year.
The transitional rules ordinarily allow historic overlap profits to be relieved against the amount in B. Any excess of B profits after overlap relief may be spread over up to five tax years. Special rules apply where overlap relief creates or contributes to a loss.
Who is not affected?
If the LLP accounting date is already between 31 March and 5 April, the change should have no impact (assuming overlap relief was correctly claimed on any prior accounting date changes).
What to do now?
Although the first affected return (2023/24) is not due online until 31 January 2025, impacts should be assessed now.
For example, 2021/22 tax returns should show overlap profits carried forward so that the amount:
- continues to be tracked and not forgotten, and
- is readily available for 2023/24 filings.
As HMRC notes in the Business Income Manual, unused overlap relief cannot be deducted after the transitional window and will effectively be lost after 2023/24.
Individuals who joined partnerships with non-31 March to 5 April year-ends and were allocated opening-year profits will typically have overlap profits. If those figures are absent from returns (and were not used on a prior accounting date change), this should be investigated now rather than relying solely on HMRC records.
From 2024/25 onward, where accounts are prepared to a date other than tax year-end, taxable profits are generally apportioned across two accounting periods that straddle the tax year. LLPs may therefore consider an accounting date change to avoid:
- administrative burden from apportionment, and
- confusion for members who are used to the current basis.
Using 2024/25 as an example, a long-standing member of a UK LLP with a 31 December year-end may need profits from 6 April 2024 to 31 December 2024 and 1 January 2025 to 5 April 2025 in the return for year ended 5 April 2025. HMRC has indicated that some businesses may need to use provisional figures on returns.
A business does not have to change accounting date. The burden can be reduced with experienced support, but timing still matters. Existing restrictions on accounting date changes continue to apply before transitional rules and are removed from 2023/24 onward. For some groups, such as US-headquartered businesses consolidating UK subsidiaries, moving away from a December year-end may also be commercially unattractive.
Contacts
If you have any questions regarding the topics discussed in this article, please get in touch with Jon Hanifan, Business Development Director, or Sutharman Kanagarajah, Head of Tax.