What does basis period reform mean for your business?

5th October 2022

The rules HMRC use to work out sole traders’ and partners’ profits for Income Tax in a Self Assessment return are changing. In this article we explain basis period reform, who’s affected and what this means for your business.

What’s changing?

HMRC is changing the rules it uses to calculate sole traders’ and partners’ Income Tax in a Self Assessment return. Currently, unincorporated trading businesses (i.e. sole traders, partnerships and LLPs) are taxed on profits for the accounting year ending in a tax year. For example, if trading profits for the year ended 30 April 2021, this will be assessed in the tax year 2021/22 as the accounting date falls within the period of the tax year.

Under the current rules, there can be overlapping basis periods (e.g. if a new partner is appointed, during the opening/closing years of business, or if there is a change to the accounting period). This means that profits can be taxed twice. In these instances, businesses can claim overlap relief when the business ceases or a partner retires, in the form of a reduction. The current rules can allow for a significant tax deferral – for example, a business with a 30 April year end, will not pay tax on all of its profits until 21 months after that date.

However, from April 2024, businesses will be taxed on profits for the corresponding tax year, regardless of the business accounting date. From the tax year 2024/25 and future years where accounting years are different from the tax year end, the taxable profits will be calculated by apportioning the profits for the two accounting periods straddling the tax year.

Who is affected by the Self Assessment changes?

Only taxpayers with an accounting date other than 31 March or 5 April are affected by the basis period reform.

Why is the basis period reform happening?

Basis period reform is part of the Government’s overall plans for introducing Making Tax Digital (MTD), which is due to be extended to self-employed businesses from April 2024. Under the new rules, the basis assessment for trading profits will be simplified and aligned with other sources of income. Limited partnerships, LLPs and businesses with corporate partners are not required to join MTD for Income Tax in April 2024 but it is expected they will be at a later date yet to be announced.

What does basis period reform mean for the current tax year?

The current tax year 2023/24 is a transition year. This means self-employed businesses will move to the new way of calculating taxable profits for the tax year. Businesses will need to declare the total profits from the end of the last accounting date in the tax year 2022 to 2023, up to 5 April 2024. This means profits generated over a longer period will be taxable in the transition year.

In the tax year 2023/24 businesses can use any overlap relief resulting from overlap profit when the business first started. By default, any remaining additional profit can be spread over five years.

Example: a business’s accounting date is 31 December. They must declare profits from 1 January 2023 to 4 April 2024 in their tax return for the tax year 2023/24, which is payable by 31 January 2025.

What does basis period reform mean for your business?

The biggest change for businesses is that those whose accounting period does not match the tax year will be required to apportion profits to adjust their taxable results to the tax year basis.

Many businesses will be required to pay their tax bills much sooner than under the previous rules. It may also push individuals into a higher tax rate band – particularly if the business ceases before the fifth year of trading.

Under the new rules, businesses who do not currently draw accounts to the end of the tax year or 31 March will have a much shorter period to finalise their figures. For example, a business drawing accounts to 30 April currently have 22 months before they are required to file their Self Assessment, however under the current rules this will be reduced to just 10 months.

The transition year 2023/24 presents an opportunity for all businesses currently trading, regardless of accounting date, to use any overlap relief due.

From the tax year 2023/24 onwards, some businesses may need to use provisional figures on their returns. More information is expected to be released about this in due course.

If your business’s accounting date is changed in the current tax year 2022/23, the current change of accounting date rules will still apply. If your business decides to change its accounting date from the tax year 2023/24 onwards, the current rules will not apply and a change can be made regardless of previous changes.

Talk to the experts

We know these changes might be confusing and cause complications for your business. If you have any questions about basis period reform, or need support through the transition, get in touch with our friendly and professional team.

All information correct at time of going to print/live and on the best knowledge and understanding of the author at the time. This article is for general information only and does not constitute financial advice or recommendations for individual circumstances. No responsibility is taken for any actions taken on the base of the information within this article.

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