Basis Period Reform – for sole traders and partnerships

Are you self-employed, or a partner in a trading partnership? If so, you should be aware of how the ‘basis period reform’ may affect you.

HMRC is moving from a ‘current year’ basis to a ‘tax year’ basis. For affected businesses (those that don’t have a year-end of 31 March or 5 April), this could mean a much larger tax bill for the 2023/24 tax year, along with significant one-off and other ongoing costs and administrative burdens.

So, when are these changes coming in? And what will the potential impact be for sole traders and partners?

What does a change in the basis period mean?

Self-employed people and partners in trading partnerships generally prepare accounts to the same fixed date each year. This is known as the ‘basis period’. Ignoring the existing ‘opening/closing year’ rules, for tax purposes, profits are currently taxed in the tax year in which the basis period ends. For example, if your business has a 30 June period end, profits for the year to 30/06/2022 would be taxed in the 2022/23 tax year ending 5 April 2023. The tax would then be payable by January 2024.

However, from the 2024/25 tax year beginning on 6 April 2024, businesses will be taxed on a tax-year basis meaning they will pay tax for the 2024/25 year on profits earned in that tax year. There will be no change for those taxpayers with an existing accounting date of 31 March or 5 April, but for those with a different accounting date, you will either need to change this to conform, or apportion profits between tax years. If you decide to change your year end, the timing will be important because you can only access ‘spreading’ (see below) if the change is made in 2023/24. There will be special rules for those with accounting dates that fall between 31 March to 5 April to prevent businesses having to apportion small amounts of profits.

The 2023/24 tax year is a transitional year in which all affected businesses will be taxed on the profits for their basis period as now (the ‘standard’ part), plus the tax on their profits from the end of that basis period up to 5 April 2024 (the ‘transitional’ part).

For example, consider a business with a 30 June period end: in the 2023/24 tax year, they would be taxed on profits for the accounting year ended 30 June 2023, plus profits arising during the period 01/07/2023 to 05/04/2024. So effectively, they would be taxed on 21 months of profits instead of 12. It may be possible to spread the excess profits, but the change in basis period will result in some profits being taxed earlier than they would be under the existing rules.

Where accounts have not been prepared for the later period, it will be necessary to file using provisional figures and subsequently ‘correct’ these, which will increase the administrative burden and associated costs.

Some businesses will be able to claim transitional relief if they have overlap profits brought forward. This represents profits that were taxed twice in the early years of trading under the current regime. The overlap profit can be deducted from the profits arising in the transition part, with overlap relief either used in 2023/24, or lost. It may be possible for any additional taxable profits to be spread over up to five years, to reduce the impact, although there are a few exceptions. It is also possible for a trader to elect for an additional amount of the transition profits to be treated as arising in a specific tax year, so the spread may be unequal.

The change to the basis period will simplify reporting requirements as the Making Tax Digital for Income Tax Self-Assessment (MTD ITSA) changes are eventually rolled out. This change to the basis period brings all other forms of income for individuals into account on a tax-year basis, making the whole process easier to administer.

Talk to us about the proposed changes to your accounting period-end

If the year-end for your business is not currently 31 March or 5 April, you will potentially be taxed on more than a year’s profits in 2023/24.

Even with a facility to spread the excess, your tax bill could be higher. The transitional profits are excluded from the net income amount to reduce the impact on certain benefits and allowances, but the tax that would have been charged on them will be added to the tax calculation.

For affected businesses, we can help you prepare forecasts of the likely impact and consider ways to ease the transition.

If you would like any further information or advice, please contact our Senior Tax Manager, Vanessa Glenn.

Email: [email protected]

Phone: 02476 306029