HMRC’s reform of the basis of taxation for self employed individuals and partners is set to take effect from April 2024, with a 2023/24 transition year.
The changes will affect all sole traders, unincorporated partnerships and LLPs who do not currently prepare their annual accounts to a reference date ending between 31 March and 5 April.
What are the current basis period rules?
Currently, established sole traders and partners/members in ongoing businesses pay tax for a tax year based on the financial performance of the business in the 12 month accounting period which ends in that tax year. If a business prepares accounts for the 12 months ending 30 April 2022, then the profits from this period, after adjustments, would be taxed in the individual’s tax return for the 2022/23 tax year, with payments of tax in January and July 2023 and a balancing payment in January 2024.
This is known as the ‘current year basis’ and the period being taxed is the ‘basis period’.
What are the proposed new rules?
From 2024/25, all unincorporated businesses will be taxed on the profits generated during the actual tax year, regardless of the year end that the business chooses to prepare its account to. HMRC do, however, allow a year end that falls between 31 March and 5 April to be treated as if it falls at the end of the tax year.
If a business has an accounting year end of 31 December, it will have to apportion profits from two accounting periods to fit the 6 April to 5 April timeline. If the accounts have not been finalised before the tax return filing deadline, then estimated profits will need to be included, which will then need to be revised on the return once the actual figures for the later accounting period are known.
HMRC recognises the additional administrative burden this will cause and are reportedly exploring ways to ease this.
In practical terms, it is likely that most businesses will choose to move to a 31 March or 5 April year end if they can, in order to avoid such complications. If so, it is important that this is done in the transition year 2023/24.
2023/24 – the transition year
2023/24 will be a key tax year for the proposed new rules, as the transition year, and individuals will be taxed on a long period of account ending 5 April 2024. This period will therefore pick up all untaxed accounting profits generated up to this date and relief will be given for any overlap profits generated under the current basis period rules.
For a business with a 30 April year end, this means that the profits of the 23 month period from 1 May 2022 to 5 April 2024 will be taxed in that year, less the overlap profits which arose in each partner’s first year of business.
Transitional profit spreading
HMRC have published rules that allow the payment of the tax liability generated from transitional period profits to be spread over five tax years, beginning with the year of the transition – a decision that should help to ease cashflow by ensuring the tax due on these profits is not paid entirely in 2023/24.
To benefit from this, it is vital that businesses changing their year end do so within the transitional period. If the change was done beforehand, for example to 31 March 2023, tax would be accelerated but no spreading would be possible.
What are the possible complications?
The acceleration of profits for five years could create some complications depending on the individual’s level on income. For example, the £100,000 limit for the personal allowance or the £50,000 limit for High Income Child Benefit Charge.
The proposed reform to the basis period method includes provisions to mitigate the impact of the changes by removing the transitional profits from the main tax computation and creating a stand alone income tax charge. Although this provision will prevent some anomalies, such as the High Income Child Benefit Charge, the personal allowance taper anomaly remains and there could also be complications with income limits for pension contribution purposes.
What should I be thinking about now?
- Make sure you understand the cashflow implications of the changes and how you will manage them; and
- Determine whether changing your year end to 31 March will make the calculation of taxable profits from 2024/25 clearer. If so, there will be various practical implications of that to consider for the business.
Get in touch
If you would like further clarification on how the basis period reform and transitional rules will affect you and your business, get in touch with our tax experts who can help ensure you are prepared for the changes. Speak to your usual adviser, or email firstname.lastname@example.org for more information.