Taxation of the unincorporated business for ATX-UK

The new business
Part 1 of 2

This is the Finance Act 2023 version of this article. It is relevant for candidates sitting the ATX-UK exam in the period 1 June 2024 to 31 March 2025. Candidates sitting ATX-UK after 31 March 2025 should refer to the Finance Act 2024 version of this article (to be published on the ACCA website in 2025).

This is the first of two articles on the taxation of unincorporated businesses. It covers issues relating to a new business including the choice of business vehicle and the first years of trading. The second article (‘the existing business’) looks at issues relating to the final years of a business. These articles only cover a selection of issues: there are other matters that, while not featuring in these articles, may still be the subject of a question in the exam.

The taxation of unincorporated businesses is an important part of the ATX-UK syllabus and is examined regularly. Almost all of the relevant technical rules relating to income tax and national insurance contributions are covered in the TX-UK syllabus, so there is little that is new at ATX-UK. However, these rules continue to be of vital importance – a sound knowledge of these rules will enable candidates sitting the advanced taxation paper to identify the relevant issues and taxes from the information provided, and to consider the implications of alternative courses of action.

This is not an introductory article: it is relevant to students coming to the end of their studies and finalising their preparations to sit the exam. It is intended to be read proactively – ie statements made should be confirmed as true by reference to the reader’s understanding of the rules or to a relevant study text. This approach will enable situations to be analysed from first principles rather than by reference to a rigid set of memorised planning points.

What is required at ATX-UK?

Questions in the exam are likely to be based around the commercial decisions of the taxpayer. They will require candidates to have a strong knowledge of the technical rules and an ability to apply those rules briskly and accurately. Candidates may be required to identify options that are obviously advantageous, disadvantageous or irrelevant, without preparing detailed calculations – for example, by recognising that a particular strategy relating to the use of losses would simply result in a waste of the personal allowance.

Some fundamentals

The basis of assessment
The taxable profits of an unincorporated business are determined in two stages:

1. The profits per the accounts are adjusted for tax purposes
   
   For a partnership, the tax-adjusted profits are then divided between the partners in accordance with the profit-sharing arrangements of the trading period.
   
   
2. The tax year basis of assessment (see below) is then then applied to the sole trader’s or partner’s tax adjusted profits of the trading periods.

Tax year basis of assessment
From the tax year 2024-25 onwards, the CURRENT YEAR basis of assessment for unincorporated traders (sole traders and partnerships) is to be replaced by the TAX YEAR basis.

As a result of this you need to know the following:

• The current year basis of assessment opening and closing year rules and the rules concerning overlap profits (ie the rules that you have come to know and love during your studies of the UK tax system) are no longer examinable.
• A change of accounting date no longer has an impact on the timing of taxation of profits, such that the rules for calculating assessable profits on a change of accounting date no longer apply.
• There are no longer any tax advantages when it comes to the choice of accounting date (for example, 5 April compared to a date early in the tax year such as 30 April), although an accounting date of 5 April (or 31 March) is more straightforward given it ties in with the tax year.
• The tax year 2023-24 is the transitional year, and special rules apply for any unincorporated business which does not have an accounting period ending on 5 April (or 31 March). These rules may give rise to transition profits in the tax year 2023/24.
• The transition from the current year basis to the tax year basis will use all of a trader’s overlap profits in the transitional tax year 2023/24.

For exams in the period 1 June 2024 to 31 March 2025 (ie the period in which you are taking this exam):

• The calculation of taxable profits under the new tax year basis is not examinable.
• The transitional rules which apply in the tax year 2023-24, including the calculation of transition profits, are not examinable.
  
  However, you are expected to know that transition profits will be subject to income tax in future tax years.
  
  
• Calculations of income tax liabilities where there are transition profits are not examinable.

As a result of these exclusions, for exams in the period 1 June 2024 to 31 March 2025:

• An unincorporated business will always have an accounting period ending on 5 April (or 31 March) in questions where you are required to calculate the assessable profits for a tax year.
• Where a question involves an unincorporated business which does not have an accounting period ending on 5 April (or 31 March), the taxable trading profit for the relevant tax year(s) will be provided.
• Where a question involves the commencement or cessation of an unincorporated business, the taxable trading profit for the relevant tax year(s) will be provided.

Trading losses
Where there is a tax adjusted trading loss in a basis period, the trader’s taxable trading income for the related tax year will be zero. There will also be a loss available for offset against income and/or chargeable gains. There are two main issues that candidates need to be sure of in order to be able to calculate the potential tax saving from the offset of the losses:

1. The precise income and/or chargeable gains that the losses can be offset against, and
2. The periods in which the offset can occur.

Candidates must then take care to consider all of the relevant possibilities in the detail necessary to provide the advice requested.

Pre-trading expenditure
Expenditure incurred in the seven years prior to the commencement of trade is treated as having been incurred on the first day of trading.

Capital allowances
For the purposes of capital allowances, assets purchased for use in the business prior to the commencement of trading are treated as having been purchased on the first day of trading. Assets owned by the trader and brought into the business are treated as having been acquired for their market value at the time they are brought into the business.

The annual investment allowance is increased/reduced for trading periods of more/less than 12 months. Accordingly, the length of the trading period in which significant capital expenditure is incurred can have an effect on the speed with which a business obtains relief for its capital expenditure.

Choice of business vehicle

Unincorporated business or company?
A new business can be operated as an unincorporated entity (sole trader or partnership) or as a company. The choice will be made by reference to commercial and legal issues in addition to taking into account the tax implications of the alternative business structures. Commercial issues include the effect of the chosen business vehicle on the ability of the business to raise finance, and the possible belief that a company may be regarded as larger or more financially sound than an unincorporated business. Legal issues include the possibility of dividing the ownership of the business between a number of different owners and the existence of limited liability.

Employ or form partnership?
Where two people are to work together in an unincorporated business, it may be appropriate to consider operating as a partnership as opposed to one of them employing the other. As always, there are legal and commercial implications as well as tax issues to consider here. In particular, it should be recognised that entering into a partnership is a significant transaction due to the ability of one partner to enter into a contract that binds the other partner.

From a tax point of view, the decision requires a comparison of the tax position of an employee with that of a self-employed person. In addition, where the business is loss-making, there is also the issue that the costs of employing someone will create tax and national insurance liabilities (despite the business not being profitable). These employment costs will, of course, increase the loss available for relief, but there is likely to be a timing difference between obtaining relief for the loss and paying the employee taxes.

Conclusion

The rules governing the offset of losses are of fundamental importance in the exam. You must ensure that you can apply the rules efficiently and accurately.

Note: The unincorporated business is considered further in: 

• Taxation of the unincorporated business – the existing business for ATX-UK

Written by a member of the ATX-UK examining team

The comments in this article do not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content of this article as the basis of any decision. The authors and ACCA expressly disclaim all liability to any person in respect of any indirect, incidental, consequential or other damages relating to the use of this article.