What is Basis Period Reform and who’s affected?
The commencement of Basis Period Reform draws near, with April 2024 heralding a significant shift for sole trader and partnership taxpayers in their Income Tax reporting, as mandated by HMRC.
While only about 7% of sole traders are expected to feel the impact, a substantial 33% of partnerships will likely be affected by this reform. The 2023/24 tax year serves as a transitional phase, demanding additional administrative efforts to ensure compliance for taxpayers.
How have you been taxed previously?
Previously, we’ve used 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 was taxed on that income in the tax year 2022/23 (assuming that the business was 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 no 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.
Why is the new basis period coming into place?
The rationale behind Basis Period Reform is to tax profits closer to their earning time, enhancing tax planning, compliance, and reducing tax debt write-offs. This reform aligns Income Tax reporting with other income types like property income, interest, and dividends, streamlining the reporting period for all income sources.
Adopting a tax-year basis ahead of the implementation of Making Tax Digital (MTD) for Income Tax offers additional benefits, allowing sole traders and partners to familiarise themselves with tax-year reporting in advance.
What are the two phases of Basis Period Reform?
Basis Period Reform unfolds in two phases: a transitional period for the 2023/24 tax year and full implementation in the 2024/25 tax year .
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.
How does the transitional period work?
For taxpayers who aren’t already following the tax year basis, they will need to apportion profits from two accounting periods to complete their 2023/24 Income Tax Return. Let’s look at an example:
Margaret, has a 31st December year-end.
Her basis period for the 2023/24 tax year has two parts:
Her accounting year: 1st January 2023 – 31st December 2023
Plus, the transitional part: 1st January 2024 – 31st March 2024
In total, Margaret will be taxed on 15 months’ profit for her 2023/24 Income Tax Return. During this transitional period, tax bills are likely to be higher for taxpayers who don’t already use the tax-year basis. To accommodate higher tax bills, HMRC is allowing taxpayers to spread these overlap profits over five years and ease the impact on their cash flow.
Some taxpayers may also be entitled to overlap relief if they started trading with a non-tax year-aligned accounting date. We can help you claim this on your behalf during the transitional year if you have access to the additional tax amounts.
Other considerations
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.
To discuss how any of these changes may impact yourself or your business, please feel free to reach out to our friendly team on 01772 204102.