The Revenue closes in: Self-employed people will be watched closely under a new tax system. Andrew Bibby reports

THE INLAND Revenue this week firmly slapped down any fond hopes that self-employed people will be able to benefit from lower taxes during the forthcoming switch-over to a new method of tax assessment.

The change announced on Thursday by the Financial Secretary to the Treasury, Stephen Dorrell, will eventually move sole traders and partners closer to the 'pay-as-you-earn' principle applied to employees, in that their income tax will be levied on the current year's business profits instead of the previous year's results.

'It's a massive change. While the long-term picture may be much simpler, for many businesses the transition will be a period of complexity,' says George Bull, tax partner at Robson Rhodes, the accountants.

Anyone starting a business after 6 April this year will immediately operate under the new tax rules. People already self-employed move to the new regime in 1997/8 but are about to enter a transitional period when two years' trading profits are to be squeezed into one tax year. The Revenue has now indicated just how closely it will be monitoring this period.

Although the tax year affected is not until 1996/7, the period of transition begins as soon as 1 May this year for businesses using the popular April year-end for their accounts. Two years of profits (in their case 1 May 1994-30 April 1996) will in effect only be half- taxed when the tax comes to be paid in January and July 1997.

'If you can get some super- profits into the basis period for 1996/7, then only half of such profits are going to be taxed,' Brian Todd of Coopers and Lybrand says. In other words, some people might be tempted to plan to incur heavy business expenditure just before or after the two-year transition, while trying to arrange for as much income as possible to fall within the period.

The Revenue says it will be watching for 'trigger' events like these, which suggest that tax avoidance is taking place. If so, businesses can expect the lost profit to be taxed fully (indeed, the rules have a penal element which means that more tax will ultimately be paid). To avoid this, businesses will have to show that the actions they took were not for tax avoidance reasons or were solely for 'bona fide commercial reasons'.

Ian Luder of Arthur Andersen, the incoming president of the Institute of Taxation, says the Revenue has tightened its wording so that what it describes as 'changes in business behaviour' can become a potential trigger event. 'We should be talking of major changes, not just any changes. This is very unfortunate and something we shall make representations about,' he says.

The Revenue says it will disregard small amounts of profit, although it will deliberately not say until 1997 what the minimum limit will be. Very small businesses will probably escape Revenue attention.

'There is probably going to be some scope at the margins,' Mr Luder says. 'A greengrocer, say, could decide to repaint his shop-front in May 1997, rather than March 1997 when he would only get half the tax relief - jolly good luck to him.'

The Revenue will also be closely monitoring any moves to change the date of the business's year-end. 'Generally there is going to have to be a bona fide commercial reason for changing the accounting period,' George Bull says.

The issue is complicated, however, by the fact that many of the old advantages of choosing a tax year-end close to the start of the tax year will disappear under the new rules. The Revenue hopes that many new start-ups will make their business year coincide with the tax year, the simplest arrangement. Businesses with other accounting year-ends will find that their tax affairs are complicated by the concept of 'overlap relief', an accounting device designed to avoid double taxation of profits and to ensure that the right amount of tax is paid over the full lifespan of the business.

Accountants are less convinced that businesses should automatically opt for the tax year-end for their own accounts. 'An accounting date early in the tax year, such as 30 April, gives the longest period to produce the accounts and tax returns,' Brian Todd says. 'There can also be a minor cash-flow advantage.' Since the Revenue will use the previous year's profit level when estimating current-year profits, businesses that are experiencing fast-growing profits will in the short term pay a little less in tax.

Anyone about to start as self- employed needs to decide not just which accounting year- end to choose but also whether they can still sneak in quickly under the old rules. Brian Todd says the circumstances of each new business are different, but adds: 'If someone is on the point of starting to trade, it is probably preferable to try to get some sort of trading transaction in before 6 April this year.'

(Photograph omitted)