Basis period reform and unintended consequences for partners with profit shares around £100,000. 

From 6 April 2023, partners in firms which do not have a 31 March or 5 April year end will be subject to a new basis of taxation. To date, much of the current narrative is focused on the administration complexities, acceleration of tax and the cashflow implications for businesses who reserve tax for their members.

These issues, which are discussed in more detail here are undoubtedly significant. 

However, a further key consideration at an individual level is the increased tax liability certain partners face if their earnings are near the personal allowance tapering threshold level (£100,000 per annum). 

The issue

For some partners, not only will their tax accelerate, but they could also see an increase in the overall amount of tax due as a result of this reform.

Example:

In the example above, regardless of whether the partner spreads the ANP of £25,000 over five years or is taxed in full in 2023/24, the partner is going to be paying tax at 60% on that income. 

In the absence of the new rules, the tax rate would have been 40% and so this partner will be £5,000 (£25,000 x (60%-40%)) out of pocket as a result of the reform.

A similar issue arises for partners where the ANP takes them into a higher rate band, from the 20% to 40% above £50,270 and 40% to 45% above £125,140.

The planning opportunity

The calculation of ANI involves taking a partner’s total income in the tax year and deducting gross personal pension contributions and Gift Aid payments. Therefore, making it possible for a partner to reduce their ANI to below the £100,000 threshold and avoid the 60% tax rate and instead contribute into their pension or a donation to charity.

Those partners that are likely to fall into this category may well be fixed share partners and hence the issue should be foreseeable by them, their advisers and their firms. It is therefore important for all parties to work together and limit the impact, by considering the optimal level of pension contribution/Gift Aid payments to be made to soften the tax hit. 

Optimising pension contributions 

The effect of pension contributions can be illustrated by continuing the previous example and assuming a partner decided to spread the ANP over 5 years. In this situation, a partner could contribute into their pension of £4,000 net each year (£5,000 gross), reducing their ANI from £105,000 to £100,000, thus avoiding the 60% tax rate on the ANP. 

Other considerations

Many firms that reserve partners’ taxes will, no doubt, be having strategy meetings in the coming months to decide on the business’ policy on the reform, most likely with the aim of taking a uniform approach. 

For example, the decision may be that all members are to spread their ANP over five years to lessen the cashflow burden on the firm. 

It may be assumed that taking this uniform approach is only a cashflow issue, however, there may be some partners who are out of pocket by electing to spread. This could occur in our example if the ANP for a partner exceeded £25,140 (say £30,000), as the tax rate on earnings over £125,140 drops back down to 45%. The tax liabilities would be as follows:

ANP = £30,000
Spread tax liability = £6,000 x 60% x 5 = £18,000
No spread tax liability = (£25,140 x 60%) + (£4,860 x 45%) = £17,271

The reality is that, in most cases, this may only be an issue for a few members of the firm, in which case exceptions could be made.

However, if there is a sizeable group of partners affected by this particular impact then the decision of whether to “spread” could be more problematic.

Next steps

Firms need to start reflecting on the implication of the new basis period reform and look strategically at the numbers for different levels of partners and of course the cashflow implications.

For more information, or to discuss the impact on your firm, get in touch with your usual Crowe contact.