On 27 January 2022, the Government published proposed amendments to Finance (No. 2) Bill 2021/22 to adjust the Basis period reform transitional rules. The changes seek to remove some unintended but unfair outcomes that could have arisen from the draft legislation. International partnerships will now not lose out on double tax relief, and individuals will have more flexibility in claiming certain reliefs.
BDO has worked constructively with HMRC in identifying and finding solutions to these issues, so we are pleased that the Government has taken a practical approach to make the transitional rules as fair as possible.
What was the issue?
The draft basis period reform legislation separates transitional profits from ‘normal’ profits, and taxes them as a ‘stand-alone’ amount, to ensure continued entitlement to means-tested benefits and the pension annual allowance. However, the original proposed mechanics raised potential issues with claiming double taxation relief on overseas partnerships profits included in the transitional profits, and certain other reliefs.
The latest technical changes
1. Transition period profits will still be separated out in the tax calculation as a separate component and will not affect the level of the individual’s net income used to calculate entitlement to certain reliefs and benefits (including the individual’s pension annual allowance).
2. A stand-alone tax amount will still be calculated on the transition component by comparing:
- the total tax that would be determined at Step 5 (section 23 ITA 2007) with the transition component excluded from net income, and
- the total tax that would be determined at Step 5 with the transition component included in net income (meaning that the transition component will impact the amount of personal allowance available).
3. The stand-alone tax amount will now be treated as if it were an amount of tax calculated at Step 4, and form part of the total tax determined at Step 5 of the tax calculation (instead of being brought in at Step 7).
Impact for partners with overseas profits
It will now be possible to claim double tax relief on any overseas partnership profits included in the transitional profit. There may have been a theoretical argument for claiming double tax relief under the prior proposals, but the updated proposal puts this beyond doubt - a particularly helpful change for partnerships that operate internationally.
Although, in principle, overseas taxes suffered on foreign profits arising in the transitional period will now be relievable, there will nevertheless be practical difficulties in determining the foreign tax credits that can be claimed. This will be particularly complex where the transition period profits are spread over multiple years (up to five years). Firms with significant foreign profits may need to weigh up the benefits to cash flow of being able to spread the transitional profits with the additional complication that this will create for claiming double taxation relief.
More flexibility in claiming certain reliefs
All individuals may also benefit from another consequence of this change in the tax calculation: this arises from the fact that income tax relief for EIS, SEIS and VCT investments is given at the same step of the income tax calculation as double tax relief. This means that if individuals make such investments in 2023/24 (or another year when part of the stand-alone tax amount is charged to tax), the relevant income tax relief can be claimed against the stand-alone tax amount as well as their other income in that year.
Next steps
The Finance Bill is still subject to Parliamentary debate, and it may be some weeks before the final legislation is enacted. However, the impact of the transitional rules is now clearer, and partnerships, individuals and their advisers are in a better position to make decisions on issues such as changing their firm’s accounting date and whether or not to elect to spread the standalone transitional tax amount.
We also look forward to discussions with HMRC on other issues regarding the increased administration around the annual amendments that the new regime will require from many firms.
For further information, or for assistance, please contact a member of our team.