If you are a partner in an LLP with an accounting year end which does not fall on 5 April or 31 March then read on…
From the tax year 2023-2024 all partners (members in an LLP) of trading partnerships will report and pay tax on profits which actually arise during the tax year.
If the partnership’s accounting period does not align to the tax year the partner must apportion two accounting periods when preparing their self-assessment return. The change does not impact on the partnership/LLP itself, as it can still prepare its accounts to any date it chooses and will file a tax return prepared based on the accounts to that date.
There are a number of reasons why certain asset managers structured as LLPs have an accounting year end which is not 31 March or 5 April. Perhaps the most common is when an asset manager has a US connection and therefore has a 31 December year end to align with the US tax reporting. Under the new rules, individual members in such LLPs will have to estimate their profit allocations for their UK tax filings and then resubmit their tax returns once final allocations are available, this will increase cost and time spent on tax compliance. Also, there is higher scope for interest charges on underpaid tax and penalties for non-compliance.
Original basis period rules
The basis period system used the “current year basis” where the general rule is that the basis period for a tax year is the period of 12 months ending with the accounting date in that tax year.
The original rules mean that in certain circumstances basis periods can overlap, especially during the early years of trading. The profit arising in the overlap period is then taxed twice, once in the first basis period’s tax year and again in the second basis period’s tax year.
In the example below, XYZ LLP’s is a hedge fund manager with an accounting year end 31 December. A member joined on 1 January 2022. The member is taxable on profits allocated from XYZ LLP for the period from 1 January 2022 to 5 April 2022 in 2021-2022 tax year and then in tax year 2022-2023 the member is taxed on the profits allocated to him from XYZ LLP for the period from 1 January 2022 to 31 December 2022 (XYZ LLP’s accounting period). The overlap profit is approximately 3 months of profits from 1 January 2022 to 5 April 2022 taxed twice. The overlap means that in those two tax years the member is taxed on the profits of the same number of months they have traded in those tax years.
While the original system aimed to ensure that all the profits of the business are captured, it was complex and overlap relief may not have been claimed by all the individuals members.
New rules from 2024-2025
From 6 April 2024 assessment of individuals moved to a new “tax year” basis of taxation. Instead of being taxed on the accounting period of the partnership ending in the tax year, the individual member will always be taxed on the profits arising in the tax year. That is from 6 April to the following 5 April.
In the example, where XYZ LLP has the accounting period end 31 December, in order to apply the new rules partner’s tax return has to include the following profits of XYZ LLP:
- For the accounting period ending on 31 December in the tax year, that part of the profits from 6 April to 31 December.
- For the accounting period ending in the following tax year, that part of the profits from 1 January to 5 April.
Or as illustrated below for the tax year 2024-2025, individual members in XYZ LLP will be taxable their profit allocation for the accounting period from 1 January 2024 to 31 December 2024 (C) less their profit allocation for the period from 1 January 2024 to 5 April 2024 (A) plus their profit allocation for the period from 31 December 2024 to 5 April 2025.
The new rules can be summarised as requiring ‘overlap’ to be calculated in real time.
The part of the profits to be included in the member’s tax return must be calculated on a time basis. The default time apportionment method is to use days. That means 95 days to 5 April and 365 for the whole period. In a leap year (such as 2024) the factors are based on 96 and 366 days. An individual can also use an alternative time method, such as weeks or months provided that the method is both reasonable and used consistently.
It will not be possible to look at actual profits just from the period, for example profits made in the 95 days which is portion B. The requirement is to take the profits for the whole accounting period and then apportion. Profits of the business during the period may not be linear, in particular for managers which charge performance fees as these are often booked on 31 December after the tax year has ended. The discretionary allocations of profits to members may also not be known by the time of the submission of the return, and are likely to move up or down with the overall performance of the business.
Transitional period: 2023-2024
Tax year 2023-2024 will comprise two parts. For members of XYZ LLP:
- The first the 12 months profits to 31 December 2023, i.e. the amount that would have been included had the rules not changed (the “standard part”).
- The period from 1 January 2024 to 5 April 2024 (the “transition part”).
The profits in the transition part are reduced by the offset of the available overlap relief. If the overlap profits are not deducted in 2023-2024, they are lost, which is a real cost to an individual. Individual members can find their overlap profit on their self-assessment tax return (partnership page) or by contacting HMRC. Any positive number is referred to as transition profits. By default, these are spread evenly over 5 tax years starting in 2023-2024 to 2027-2028, with 20% of transition profits taxed in each of the tax years.
It is possible in any year to elect to accelerate all or any part of as yet untaxed transition profits. If not all of the transition profits are taxed by an election, the remaining amount continues to be spread. An election to accelerate should be made in the tax return. The time limit is the first anniversary of the normal self-assessment filing date for the relevant year. For example, an election for 2024-2025 has to be made by 31 January 2027. A claim to advance the taxation of the transitional profits might be useful if, for example, the marginal tax rate in the current period is lower or tax rates increase in the future.
If the trade ceases (for example, a member retires from the LLP) any untaxed transition profits are taxed in full in the tax year in which retirement happens.
If the overlap deduction exceeds the profits of the transition part it will result in a loss. The loss is not spread forward and can be offset against the profits of the standard part or carried back against profits of the previous 3 years.
Transitional profits are placed in a particular way in the calculation of net income. Transition profits will impact on limits for personal allowances and count for student loan repayments. They will not count for the high-income child benefit charge. On pensions, they should not affect the annual allowance tapering, although, they will count as relevant earnings for contributions relief.
If a member only joined the LLP recently the standard and transitional parts may be different to the example above. Using the example of a December year end, this would be the case for a member who joined on or after 1 January 2022.
Practical aspects
Individual members will have to file their tax return no later than 31 January after the end of the tax year. For the member in XYZ LLP, as covered above, this will include part of the profits of the LLP for its accounting period to 31 December following the end of the tax year.
If a member is looking to file their tax return for the 2023-2024 tax year no later than 31 January 2025. That includes 96/366th of the taxable profits of XYZ LLP for its accounting period ending 31 December 2024, which may not be known by 31 January 2025. XYZ LLP will have to communicate to its members when these profit allocations will be known so that the members can plan their self-assessment reporting appropriately. To the extent that an entry in a tax return is not known an estimate can be used. Any estimate has to be reasonable. Individual members have to disclose the use of estimates in their tax returns when filed.
A tax return can be corrected by the taxpayer anytime up to one year after the filing deadline for an online tax return. That is the second 31 January after the end of the tax year – 31 January 2026 for the tax year 2023-2024.
Normally HMRC would expect that a return is amended as soon as the final number is known. HMRC has indicated to the Association of Tax Technicians that a return revising the basis period numbers can be corrected at any time up to the normal amendment deadline. That would allow the preparation of the following years’ return and the amendment to be completed at the same time. While that has some practical attraction, the numbers at least should be reviewed as soon as possible. That would allow payments of tax, including payments on account, to be updated to reduce any interest on underpaid tax accruing. HMRC will charge interest on underestimated profits from the original due date of payment.
Individual members in asset managers structured as LLPs with an accounting year end which is not 31 March or 5 April should agree with their tax advisors a timetable for filing their tax returns (based on estimates and actuals) and for review of tax payments due and made, in order to avoid penalties and interest.