Unincorporated businesses (generally sole traders, partnerships, and LLPs) are currently taxed on the profits ending in the tax year, known as the current year basis. Following Finance Act 2022, from 2024/25 all unincorporated businesses will be required to align their basis periods with the tax year meaning that profits to be assessed in a tax year will be those that arise in the tax year.
The changes are being implemented to make the basis of assessment for trading profits simpler and to align with other sources of income. The reform also links in with the Government’s plan for Making Tax Digital which it is proposed will become mandatory for self-employed businesses from April 2024.
Businesses who do not currently prepare accounts to 31 March or 5 April will be impacted substantially by the new rules and should start considering the consequences of these changes as soon as possible.
Tax year basis – 2024/25 onwards
From 2024/25, taxable profits will be calculated based on the profits arising in that tax year. For businesses whose accounting periods do not end on 31 March or 5 April, profits will need to be apportioned by the number of days or another reasonable basis.
For example, if a business prepares accounts to 31 December every year, the 2024/25 taxable profits would be based on 270/336ths of the 2024 calendar year profits covering the period 6 April 2024 to 31 December 2024 and 95/365ths of the 2025 calendar year profits covering the period 1 January 2025 to 5 April 2025.
Transitional year – 2023/24
2023/24 will be a transition year and this will bridge the period between the end of the basis period for 2022/23 and the start of the reformed basis period in 2024/25. Generally, profits for 2023/24 will be based on the period from the end of the 2022/23 basis period to 5 April 2024 with a deduction for any unrelieved overlap profits. Overlap profits arise where an unincorporated business does not have an accounting year-end of either 31 March or 5 April. Special rules apply in the opening years of trade which can result in profit being taxed more than once in the first three years of trade, known as overlap profit. Profit taxed twice in the early years of trade is relieved usually on leaving the business, cessation of the business, or if the business changes its accounting date.
For businesses whose accounts are not drawn up to 31 March or 5 April, the transition year will result in a basis period longer than 12 months and there could be an additional tax charge arising if the amount of any additional profits arising from the transition is greater than the overlap profit deduction. However, the transition rules allow additional profit to be spread over 5 years starting with 2023/24, known as spreading. Businesses may, if they elect to do so, accelerate the tax charge. This is a useful planning tool for example if a business incurs significant capital expenditure in a tax year which qualifies for the Annual Investment Allowance, then they may choose to accelerate the tax charge and be assessed on additional profits for that year.
For example, if a business prepares accounts annually to 31 December, the profits for 2023/24 will be:
- Standard part (1 January 2023 to 31 December 2023)
- Transition part (1 January 2024 to 5 April 2024). Any overlap relief will be deducted from the transition part, to give the transition profit which can then be spread over 5 years.
Is a basis period the same as an accounting period?
The basis period is usually the profit or loss for the year up to the accounting date in the tax year. The accounting period is the date to which businesses draw up annual accounts. Businesses are currently assessed on profits for the basis period, which is usually the same as the accounting date, however different basis periods can apply for example in the opening years of trading where profits can be assessed based on the tax year rather than the accounting date.
Does a business have to change its accounting year end to match the tax year?
A business can continue preparing accounts to a date which does not match the tax year, however when completing the tax return the business will need to apportion profits or losses to tax years by reference to the number of days in the periods although other methods can be used if they are reasonable and used consistently.
This could cause difficulties where an accounting period ends later in the tax year, such as 31 December, as the accounts for that accounting period may not yet have been prepared when the tax return is submitted. For example, if a business has an accounting period ending 31 December 2025, the accounting period will only have ended one month prior to the tax return filing deadline of 31 January 2026, and it is unlikely that the final accounting figures will be available by the tax return deadline.
Businesses should therefore seriously consider whether they should change their accounting date however as a change of accounting date will affect each business in different ways, this must be reviewed on a case-by-case basis. Businesses considering changing their accounting date should discuss this with their tax adviser without delay to agree the best time for the change to take place as any change should take into consideration various factors such as brought forward overlap relief and the availability of spreading which can only take place if there is a transition period which requires a non-31 March or 5 April period end in the tax year 2023/24.
Trading and property businesses can treat an accounting date between 31 March and 4 April inclusive as being equivalent to ending at the end of the tax year.
Who will be affected by the reforms?
Self-employed individuals, partnerships, and trusts and estates with trading income. The changes will not affect companies except for some non-resident companies.
How are transition profits treated for Class 4 NIC?
Class 4 NIC will be chargeable on the additional profits taxed in the transition year.
What do I need to consider?
There are many other factors to consider, such as businesses in their opening years or businesses in their final year of trade and it is important that you seek advice for your specific business needs.
If your business does not currently make up accounts to 31 March or 5 April, you will need to consider the impact of the proposed changes on the cash flow of the business and consider whether the accounting date should be changed to 31 March or 5 April to simplify the calculation of assessable profits from 2024/25.
More complex cases where it may not be possible to change the accounting date should consider the processes which need to be in place to file provisional and then final tax returns for each period as the final accounts may not yet be prepared by the tax return submission deadline. HMRC have not yet issued final guidance on dealing with these practical issues.
Get in touch
If you have any further questions regarding the Basic Period Reform or any other tax matters, get in touch with our tax experts who will be happy to assist.
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