The Basis Period Reform was originally planned to coincide with Making Tax Digital (MTD), but despite MTD being postponed, HM Revenue & Customs (HMRC) will still implement the Basis Period Reform. This will have an impact on self-employed individuals and partnerships.
If you run a partnership or are self-employed, the Basis Period Reforms will impact you if your accounting date is not either March 31st or April 5th. The reform will take effect for the 2024/2025 tax year and the current tax year 2023/2024 is the transition year.
The main reason for going ahead with reforming the basis periods is to “simplify” the taxing of your trading profits. It helps HMRC with its overall plans for MTD. You’ll understand why when we explain a bit more.
Why is the basis period changing?
Currently, if you are a sole trader for example, and have a year-end of 30th April, your profits for April 2022 will be assessed in your 2023 Tax Return. This is because 30th April 2022 falls between 6th April 2022 and 5th April 2023, the dates of our tax year in the UK.
So, as you can see April 2022 profits would be reported as late as January 2024 (the deadline for the 2023 Tax Return). This is far away from where the government wants to be for MTD. There is a move towards more “real-time “tax.
If you’d like to do further reading, here’s the Governments proposal including the business impact and the economic impact of this change.
The new Tax Year Basis
Under the new proposals business profits will be taxed in the tax year they arise. So, from April 2024 all unincorporated businesses will report profits in the year they arise.
If your year-end falls on either 5th April or 31st March, you are already good to go and need not worry further. However, if it’s not the case, then do read on as things may get a bit confusing for a while.
From April 2024 you’ll be paying tax on an “actual basis”. So, if you continue with the year-end of 30th April, your profits for 2024/2025 will be calculated as:
- 1 month from the year ended 30th April 2024
- 11 months from the year ended 30th April 2025
This can get very messy and complicated. What’s more, it may have an impact on your cash flow.
A possible solution would be to move your year-end to 31st March (or 5th April) as this will help in the long run. But this is a problem if you are an international partnership, you may prefer a different year-end like for example those associated with the US most certainly prefer 31st December.
What happens in the transition?
In our example, the year ending 30th April 2023 is the transitional year and special rules will apply.
In the transition year, there will be almost two years of profits that will be taxed with a deduction for “overlap profit”
- Profits from the year ended 30th April 2023 (12months)
- Profits from 1st May 2023 to 31st March 2024 (11 Months)
So, as you can see there will be 23 months of profit assessable to tax. You can however deduct your overlap profit. This is the profit that was taxed twice when you first started the business.
To be honest, it was diligently noted in your Tax Return in the early years of self-assessment,and we are hoping HMRC is going to be able to advise taxpayers of this figure. But we know it is going to be a headache getting this information from HMRC. However, in recent news, HMRC did say they are gearing themselves up to provide this information to taxpayers promptly.
Anyhow, in this example, the first 12 months of the profits (as per the Accounts to 30th April 2023) will be the standard part. The 11 months to March 2024 will be the transitional part.
You have the option to spread the transitional profit, which is the profit remaining after deducting the overlap profit, over a period of 5 years to improve your cash flow.
It is not mandatory to choose this option, but it is advisable if you want to avoid paying higher taxes. If you decide to choose this profit spreading method, it must be done starting from the year 2023/2024.
We understand the transitional profit will be a “stand alone” tax charge and as such will not affect your Child Benefit claims.
What you need to do next
There’s a lot to think about. Should you change your year-end or should you continue as you are? Who’s got a note of the overlap profit and how long will it take HMRC to provide this figure?
It’s important to start planning now if you’ll be impacted by this change. There’s a possibility that your taxable profits could increase in 2023/2024, potentially pushing you into a higher tax bracket. To plan for this possibility, it’s recommended that you do your numbers earlier than normal.
We will guide you through the necessary changes when we prepare your next set of Accounts if you are working with us. If you are not yet working with us and are interested in partnering with us, you can find further information here