Tax Talk: Basis period reform – what it means for your business
Sole traders and partnerships that do not use the traditional 5 April (or 31 March) year end will be affected by the Government’s tax reform. We explain how.
The Finance Act 2022 brought into law the requirement for all sole traders and partnership businesses to report their income and expenses on a 5 April tax year basis, beginning with the year 2024/25.
What is the current system?
Right now a business can choose any accounting year end. This is called the ‘current year basis’. The basis period for a tax year is the 12 months ending with the accounting date in that tax year.
There are additional rules for the opening and closing years of a business, and when there is a change in the accounting period end.
The ‘current year basis’, creates overlap profits/periods where an accounting date other than 5 April (31 March is treated in the same way for these purposes) is chosen. Those overlap periods mean profits are taxed twice at the start in the opening years, with relief sometimes only being given many years down the line, when the business ceases, or the accounting date is changed to 5 April.
What are the changes?
The changes make this system simpler by moving all sole trader and partnership businesses to reporting on a 5 April year end for the tax year 2024/25 onwards.
This will coincide with the introduction for sole traders of quarterly reporting of income and expenses to HMRC under Making Tax Digital for Income Tax.
There will be a transitional year in 2023/24, in which you will be taxed on your profits on the current year basis as usual, plus the transitional profits which arise in the period from the day after the current year basis ends to 5 April 2024. Any overlap profit brought forward will be deducted from the result. No further overlap relief can be claimed.
If you start to carry on a trade (alone or in partnership) in the tax year 2023/24, and do not permanently cease to carry on that trade in that tax year, then your basis period for the tax year 2023/24, will start on the commencement date and end on 5 April 2024.
The transitional profits are treated as a separate item of taxable income when calculating the tax liability. They are left out of the adjusted net income figure used to calculate the taper of personal allowance or to trigger the High Income Child Benefit Charge.
The transitional profits will be spread over five tax years from 2023/24, with an option to accelerate the tax charge. The election can be made for any tax year, bringing an additional amount into charge for a specific tax year. This may be worthwhile if you have fluctuating profits or cash flow.
Here’s an illustration of the changes for the transitional year:
Harry is a sole trader with the following profits:
|Y/e 30 June 2023||£115,000|
|Y/e 30 June 2024||£150,000|
|Overlap profits brought forward||£55,000|
The basis period for 2023/24 (the transitional year) is:
|Current year basis – y/e 30 June 2023||£115,000|
|Transitional – 1 July 2023 to 5 April 2024|
|280 days/366 days x £150,000 =||£114,754|
|Less: overlap profit||(£55,000)|
Harry’s total taxable profit for 2023/24 is:
|Current year basis||£115,000|
|One-fifth of transitional profits||£11,950|
|Total taxable profit 2023/24||£126,950|
The transitional profits will be spread over five years. So an extra £11,950 will be taxable in each year from 2023/24 to 2027/28, unless an election is made for a specific year to tax an additional amount in that year.
What if I have a loss in that transitional year?
Rules deal with losses arising in the periods that form part of the transitional year. There are prescribed steps for calculating the loss, and the element of the loss relating to overlap profits can be treated in the same way as a terminal loss, with potential to carry back for up to three years.
What if I don’t want to change my accounting date?
It will not be mandatory for businesses to change their accounting date to 5 April. But if a business chooses for commercial reasons to retain its accounting date (say, 31 December), it will still have to report figures annually to 5 April.
This means having to apportion figures from the two accounting periods that fall within the tax year, in order to arrive at the figures that cover the year 6 April to 5 April (no apportionment will be needed for a 31 March year end).
In other words, for the tax year 2024/25, a business with a 31 December year end must report figures from the 2024 accounts for the period 6 April 2024 to 31 December 2024, and figures from the 2025 accounts for the period 1 January 2025 to 5 April 2025.
As the deadline for submission is 31 January 2026, it’s highly likely the final 2025 accounts won’t be available before the deadline, so figures will need to be estimated and provisional returns submitted to HMRC. The returns must then be amended once the final figures are available, which will increase the administrative burden and cost.
The Government believes around 528,000 sole traders and partners do not currently use a 5 April or 31 March year end. And, of those, around 278,000 (4% of sole traders and 17% of partners) will be hit by the need to prepare estimated figures, and submit amended returns later.
It therefore hopes as many businesses as possible will change their accounting date to come in line with the new rules. But, for some, external factors may mean a 5 April/31 March year end doesn’t work.
What should I do now?
Make sure you understand the changes and how they are likely to impact your business.
If you’re not aware of having a record of any overlap profits, now would be a good time to start checking or contacting HMRC to see if they have details.
In some instances, it may be beneficial to change your year end before 6 April 2023. But bear in mind you would then lose the opportunity to spread the additional profits over five years.
If you are intending to incur capital expenditure that would be eligible for capital allowances then the date you incur that expenditure may have a bearing on whether you get the relief in the year that you incur the expense, or if that relief is spread over the 5 years as part of the transitional profits. Therefore, any large items of capital expenditure may be best incurred in the “old” accounting period rather than have the expenditure fall into the transition period.
The position may also be impacted by whether you produce accounts for a long period of account, or two sets of accounts i.e. a 31 December year would mean that for the accounts starting on 1 January 2023, you could either prepare accounts for the 15 months to 31 March 2024, or two sets of accounts, one for the year to 31 December 2023 and one for the three months to 31 March 2024. The calculations for Capital Allowances will vary depending on whether you prepare accounts for a long period (time apportioned allowances), or two sets of accounts (allowances calculated in the period that the expenditure falls into). It should be noted that periods of account exceeding 18 months are not recognised as a change of accounting date for tax purposes.
Explore whether a 5 April/31 March year end will work for your business from 6 April 2024. If it does, make the change so that from 2024/25 you can benefit from the new rules.
If the change in accounting date is not practical, plan how you will obtain figures in time to report them, and decide if you may be liable to file estimated figures.
Consider looking at draft figures in advance of the change, to give you an idea of the transitional profits that may arise, and the additional tax you’ll need to pay each year for the five years. This will help you to budget.
It may seem like these changes are still some way off, but the transition year for those with a 30 April year end, started on 1 May 2022!
If you would like advice on any of the issues raised in this article, please contact Karen Ozen or Tilak Lamsal.