Basis Period Reform for the self-employed and partnerships

New legislation taking effect in 2023/24 will affect sole traders and partnerships that prepare accounts to a date other than 31 March or 5 April.

How are you taxed now?

At the moment, we use the “current year basis” which means that a business’ profit or loss for a tax year is usually the 12-month accounting period ending within the tax year. For example, a sole trader with a 12-month accounting date ending on 30th April 2022 will be taxed on that income in the tax year 2022/23 (assuming that the business is not starting, ending or changing year-end).

What’s changing?

From tax year 2024/25 onwards, the basis period reform will see a transition from the current year basis (as above) to a tax year basis. This means the profit or loss of a business will be calculated for the tax year rather than to the accounting date ending in that tax year.

There is not a requirement to prepare accounts to 31st March / 5th April each year (although we strongly recommend you do) but the legislation now requires apportionment of the tax adjusted results from each accounting period into tax years.

The problem if you choose not to change year end.

So, for example, a partnership preparing accounts to 30th June will need to take the tax adjusted results for 30th June 2024 and 30th June 2025 and:

Calculate 86/366ths of the 30th June 2024 tax adjusted results; and
Add 279/365th from the 30th June 2025 tax adjusted results,

to create a tax adjusted profit/loss figure for the year to 5th April 2025.

In some cases, the partners will not be able to finalise the figures that need to be included in their Self-Assessment tax return by the filing date, which remains as 31 January following the tax year in question. This means that they may need to submit provisional figures and then build in time to amend them later (which will lead to additional accountancy costs).

Transition in 2023/24

The tax year 2023/24 will be a transitional year where, in addition to the accounting results that are brought into account under the normal ‘current year basis’, a ‘transitional profit’ component is also brought into charge to represent the period from the end of the current year basis period to 5th April 2024 less any overlap profits.

Example

A business with an accounting date of 30th June will need to include the following results to determine the taxable profits for the transitional tax year 2023/24:

+ Results for the year ended 30th June 2023 (12 months)

+ Results from 1st July 2023 to 31st March 2024 (9 months of the accounting period to 30th June 2024)

– Less any overlap profits brought forward on commencement of the trade under the previous current year basis rules.

As you can see, this transition could result in a significantly accelerated and increased tax bill! To mitigate the cash flow impact of this, the ‘transitional component’ of the profits can be spread…

The Spreading Rules

These rules will automatically spread the ‘transitional profits’ evenly over 5 years, starting with 2023/24, unless the individual elects to accelerate the spread or ceases trading (in which case all remaining sums come into charge).

For example, the partnership referred to above would compute their 2023/24 results by:

Taxable profits for the year ended 30 June 2023, say £20,000
Plus: 280/366th of the 30 June 2024 tax adjusted results, say £15,000
Less: overlap relief, say (£5,000)
Less: profits spread into the next 4 tax years* (£8,000)
Taxable profits £22,000

* The ‘transitional profits’ would be computed as £15,000 – £5,000 (overlap) = £10,000 and spread over 5 years. The first £2,000 would be treated as arising in 2023/24, leaving £8,000 spread over the next four tax years.

If a loss arises as a result of this process, extended loss relief rules apply to any element attributable to the overlap relief deduction.

Effect of Extra Profit on Allowances

The transitional profit will create a standalone tax charge which will not affect the level of your income that is used to calculate relief on pension contributions and entitlement to Child Benefit. It could, however, lead to tapering of an individual’s tax-free personal allowance where total taxable income is in excess of £100k.