Basis period reform is intended to simplify the tax system for self-employed individuals and partners in trading partnerships/LLPs. These new rules have been introduced in advance of Making Tax Digital for Income Tax and will have effect from 6 April 2024.
The good news for some is that the new basis period rules will not affect individuals or partnerships/LLPs whose businesses have a 31 March or 5 April year end. If this is you or your business, you can stop reading now!
Under the existing ‘current year’ basis of assessment, the profits or losses of an accounting period are allocated to the tax year in which the accounting period ends. This basis requires overlap rules for opening and closing years to ensure there is no double-counting of profits across the life of a business.
The new rules remove the complexity of accounting periods and the tax year being out of sync by taxing profits that fall into the tax year in that tax year. So, going forward, there will be no overlap profits.
However, this means that profits from different accounting periods will need to be apportioned between tax years where the accounting date is anything other than 31 March/5 April. It is also likely to result in accelerated tax charges in the transitional year.
Although this is an attempt to simplify the UK tax system, the transitional rules in place are quite complex. In summary, the basis period for 2023/24 will comprise two elements:
The following will therefore be taxed in the 2023/24 tax year:
Where 2) minus 3) gives a positive number, this is the “transition profit”.
When a transition profit is produced, the tax on the transition profit will automatically be spread over the next five tax years. 20% of the transition profit will be assessed in each tax year from 2023/24 to 2027/28 to attempt to ease any cashflow issues.
If the trade ceases or a partner retires during this five year period, the balance of the transition profit will be taxed in the final year.
An election can be made to tax any or all of the excess transition profit in any given year within the five year period. This must specify the amount to be taxed. Any remaining additional profits will be spread across the number of years out of the five that still remain. The election must be made by the 31 January following the filing deadline for the tax return for the relevant year.
An existing loss for 2023/24 under the current regime is subject to normal loss relief rules. However, a loss created or increased by overlap relief in the transitional period is treated separately and the terminal loss rules will apply. Any losses generated by overlap relief will be available to carry back to set against profits of the previous three tax years.
This is the first tax year in which the new basis period rules will fully apply. Profits falling into the period from 6 April 2024 to 5 April 2025 (or 1 April 2024 to 31 March 2025) will be taxable in 2024/25.
Despite HMRC’s intention to simplify matters, the apportionment of trading profits to tax years where the accounting year end is not in line with the tax year may cause difficulties.
Accounts may not be finalised for the later part of the tax year, leading to the need for estimated figures in self-assessment tax returns and a requirement to submit amended returns when final figures are available. This could mean that the timetable for accounts and tax work might need to change, which could result in increased professional fees.
Changing the accounting period might help with this issue, but whether this is beneficial will vary from business to business, and other non-tax factors may need to be considered.
We would recommend considering tax forecasts for the transitional year to help you to decide whether a change of accounting date might be appropriate, and if the tax spreading facility will be helpful. Please get in touch if you would like our assistance.