Basis Period Reform and Changes to the Tax System
The Government announced in the Autumn Budget 2021 that basis periods would be abolished from 6 April 2024 and replaced with the tax year basis of assessment to aid and facilitate the implementation of Making Tax Digital for Income Tax. The reform seeks to align accounting and tax years to simplify the taxation of trading profits. Despite the recent announcement from HMRC that they will be delaying the proposed changes for Making Tax Digital, the basis period reform has had no such postponement and will be introduced as planned.
How will this affect me and my business?
Traders with accounting periods that are already aligned with the tax year will generally not be affected by the upcoming changes. Where a business’ current year end is not either 31 March or 5 April the way in which the tax is calculated will be changing. The new rules dictate that from 6 April 2024 all unincorporated businesses will be taxed on the profits generated between the start and the end of the tax year (6 April to 5 April). This will apply regardless of the year end that the business prepares its accounts to.
Where a business maintains a year end that does not run in line with the tax year, time apportionments from two separate accounting periods will be required each year in order to populate the figures on the tax return.
The transitional year
HMRC recognises that this will create significant disturbance when applied in real time and have provided a transitional year 2023/2024. Individuals will be taxed on a long period of account ending 5 April 2024 which will capture all untaxed profits up to this date.
When changing onto the tax year basis in the transitional year, relief will be provided for any overlap profits held (profits taxed twice on the commencement of trading).
For some individuals there may be anywhere from 12 months – 23 months being taxed in the transitional year depending on the accounting year end which is likely to bring an increase in the personal tax liabilities with the extended period. Those with a 30 April year end will be impacted most where profits will be assessed from 1 May 2022 through to 5 April 2024.
There are rules that allow the payment of any tax liability generated from transitional period profits to be spread over five tax years, beginning with the year of transition to help cashflow.
Example in Practice
Mr Smith prepares his annual accounts to 31 December each year and his profits are as follows: -
- Year to 31 December 2023: £40,000
- Year to 31 December 2024: £75,000
- Overlap profits brought forward: £4,000
- Overlap profits brought forward: £4,000
When looking at the tax year 5 April 2024 Mr Smith must be taxed on his annual profits for the standard year as usual to 31 December of £40,000. He will also be required to report transitional profits to the 5 April 2024 which will be calculated as follows: -
- Profits from 1 January to 5 April 2024 (75,000 x 96/366 days): £19,672
- Less overlap relief : £(4,000)
- Transition profits: £15,672
- Profits from 1 January to 5 April 2024 (75,000 x 96/366 days): £19,672
Mr Smith can spread the transitional profits of £15,672 over 5 years.
An added complexity to the scenario above is the Tax return filing deadline will remain 31 January 2025. There will not be sufficient time for the 31 December 2024 information to be pulled together and the accounts completed. Therefore, estimated profits for the period 6 April – 31 December 2024 will be reported on the Tax return to be updated when the accounts have been finalised.
Should I change my year end to align with the tax year?
It would appear sensible to consider a change of year end to 31 March/5 April unless there is a significant commercial reason not to do so.
The advantage of a 31 March year end date is that it provides the greatest length of time (10 months) between the year end date and the filing deadline which will remain the 31 January. It will also make for more straightforward filings with the avoidance of having to apportion profits between two separate accounting periods or using estimates as mentioned above which will likely come with extra administration responsibilities and increased professional fees.
Businesses will need to think carefully about their year end and whether a change makes commercial and financial sense. There will be some personal income tax implications which should be explored with their trusted advisor.
Callum Somers FCCA
Senior Manager
Growing up on a Dairy farm in East Devon, Callum joined Evolution ABS in 2010 and qualified as a Certified Chartered Accountant in 2015. Callum looks after a wide variety of clients, helping them meet their accountancy, payroll and tax needs.
Outside of work Callum is a very keen sportsman and particularly enjoys a game of golf or playing football for his local club.