What is the basis period reform, and why am I paying more tax?

Tim Lane Manager

Pinkham Blair Conversational Accountants Herts Beds Bucks London Tim Lane Manager

The new method of reporting will mean that from 2024/25 profits will instead be reported on the tax year (6th April to the following 5th April). I.e., For the 2024/25 tax year an August year end business would report its profits from 6 April 2024 to 5 April 2025 on it’s return, rather than 1st September 2023 to 31st August 2024 as it previously would have.

Note, this change has no effect on companies, only sole traders and partnerships.

Transitional period

To change from a current year basis to a tax year basis many sole traders and partnerships will have a transitional period during 2023/24 to bridge the gap between the end of their accounting year and the end of the tax year. For this purpose, HMRC view periods ending on all dates between 31st March and 5th April (inclusive) to end on the tax year end. As an example, a business with a year end of 31st August would report their 12 months profit to August 2023 along with their 7 months profit to 31st March 2024 in 2023/24.

As a result of this change, a business with a year end of April could be looking at 23 months’ worth of taxable profit in 2023/24. To alleviate this the transitional profits will be automatically split over five tax years, with 20% of the profits attributable to each.

If a business’ year end is already between 31st March and 5th April (inclusive), then no transitional period will be necessary.

A business may have overlap relief available from when it was first set up. If so, this can be offset against the transitional period profits to reduce the tax due. If the overlap relief is greater than the transitional profit creating a transitional loss, then this loss can apply the terminal loss relief rules to be used up. The terminal loss relief rules do not apply to any loss from the ‘current year’ period.

If you don’t know whether you have overlap relief available, or how much you have available you can request the amount from HMRC here.

Example:

A business makes £48k of taxable profit in the year to August 2023, and then £60k in the year to August 2024, and £72k in the year to August 2025. The business has £10k of overlap relief available to it. Previously the business’ taxable profits for 2023/24 would have been £48k. However, with the new rules the 2023/24 taxable profit will be the current year (August 2023) profit of £48k plus some of the transitional period profits (7/12 of August 2024 minus overlap relief) of £25k. The transitional profit will automatically be split over five years, at £5k per year, giving a taxable profit for 2023/24 of £53k.

For the tax year 2024/25 the taxable profit will be made up of the remaining 5/12 of the £60k from August 2024, plus 7/12 of the £72k from August 2025, plus £5k for the 20% of the transitional period, giving a total taxable profit of £72k.

What are a businesses’ options?

A business with a year end other than 31st March to 5th April has two choices:

  1. Keep their year end as it is and split the year’s profits into the relevant tax periods each year, resulting in their profits for a tax year being made up of two accounting periods.
  2. Move their year end to fall between 31st March and 5th April.

A business that goes with the first option with have an increased administrative burden, but may need to keep its current year end due to other commitments, such as tax periods in other countries. This administrative burden will be particularly large for those businesses with a year end towards the end of the tax year, where they may not be able to finalise the figures for the second accounting period before the tax filing deadline. For instance, a business with a February year end will only be 11 months into their second accounting period by the tax filing deadline. In these instances, HMRC allow estimates to be used on a first tax return submission, with an adjusted tax return to be submitted once the finalised figures are known.

Most businesses are choosing to go with the second option. While this causes an increased administrative and cash flow burden in the first year, it will greatly simplify future years from both a tax and admin perspective, and allowing for the longest period between the year end and the tax return deadline to prepare the account, along with no need to pro-rate the profits of two accounting periods.

How will the transitional period affect my tax?

Previously tax could be being paid on profits anywhere up to 21 months after the year end. Assuming the change of year end to March, tax will now be due only 10 months after the year end. This may cause cash flow problems for some businesses, particularly while they pay off the transitional period.

The higher taxable income caused by the 20% of transitional profits may cause increased payments on account. Care should therefore be taken to assess whether the automatic payment on account figures should be kept, or if an election to reduce them would be appropriate.

The transitional period’s income is not taken into account when applying child benefit or pension contributions thresholds. If, however, the transitional profit pushes you into the next tax rate band, then the higher tax rate will apply.

While the transitional profits are automatically split equally over a five-year period, it is possible to make an election to pull more of the profits into a given year. If, for example, a business had transitional profits of £25k, and they apply £5k of this to 2023/24, but then when preparing the 2024/25 tax return believe that their future profits will be much higher than normal, pushing them into a higher tax bracket, they may prefer to include all of the remaining £20k in 2024/25 at the lower tax rate, rather than continue to spread the profit over future years at a potentially higher rate.

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