Basis Period Reform Again

Every week we take a look at what is trending in the accountancy and tax press and share items that we think will interest you. However, these are only outlines and where they relate to tax planning should not be acted upon without looking into them more completely as everyone’s circumstances are particular to them. You need to take specific advice appropriate to your own circumstances.

While every effort is made to deliver accurate, informative and balanced articles this content is general in nature and should not be used as the sole basis for making decisions.

 

Basis Period Reform Again

Overview

From 6 April 2024, a new ‘tax year basis’ of assessment will apply to the trading profits of unincorporated businesses, such as sole traders and partners subject to income tax.  Under the tax year basis, such businesses will be taxed on the profits arising in each tax year (6 April to the following 5 April), regardless of their accounting period end date.

From 2024/25 this will replace the ‘current year’ basis, under which the tax for any one tax year is calculated using the profits of the accounting period ending in that year.  Basis period reform therefore effectively breaks the link between the accounting date chosen by a business and when they are taxed on their profits.

The tax year 2023/24 represents a transitional year, in which we switch over from the current year basis of assessment to this new tax year basis.

Basis period reform is purely tax driven.

It started on 6 April 2024 and you cannot escape it, only mitigate its affects.

Tax year 2023/24 was a transitional one, in which we switched over from the current year basis of assessment to this new tax year basis and there are specific rules to catch up the missing tax. The effects are alleviated by some spreading rules.

However, basis period reform goes far beyond this, and affecting other aspects of the tax and benefits system.

Under the transitional rules, any extra transition profits are initially excluded from the tax calculations but are then added back later and the tax on them is a standalone charge.

The exclusion of transition profits from net income generally removes some potential knock-on effects within the tax system.

HICBC

The High Income Child Benefit Charge (HICBC) threshold is based on adjusted net income. As a result, transition profits should not, on their own, cause this threshold to be breached.

Pensions

Transition profits will count towards relevant UK earnings for the purposes of tax relief on pension contributions.

Personal Allowance Tapering

Personal allowance tapering means that for every £2 that your adjusted net income exceeds £100,000, £1 of your personal allowance is lost. This includes traditional profits, meaning that you could be paying tax at rates in excess of 60% on them.

Tax payments

As POAs are based on the previous year’s tax liability, where this liability was higher due to transition profits being brought into account, current year POAs will also be increased.

POAs may therefore be higher 2024/25 and beyond, if you choose to spread any transition profits.

CGT rates

The capital gains tax rates will not be affected by the existence of transition profits. This is on the grounds that transition profits aren’t charged to any particular rate of income tax, instead there is a standalone tax charge on them.

Benefits and student loans

Taxpayers who receive tax credits or universal credit are required to report their earnings to the Department for Work and Pensions (DWP).

It appears that transition profits should not be included when reporting earnings for the renewals process. Similarly, for universal credit, transition profits should not be included in the earnings reported each month.

However, if additional tax or NICs are paid because of basis period reform, this could affect a taxpayer’s universal credit.

HMRC Interactive Tool

The 2023/24 self-assessment season opened on 6 April 2024. This is the first year in which profits need to be reported to the tax year end.

You can access a gov.uk interactive tool to help you navigate the changeover. According to HMRC, the tool will help sole traders complete their 2023/24 self-assessment tax return correctly based on the details they provide about their business, profits, losses and other information.

Filling in the SA return

The boxes relating to basis period reform are boxes 66 to 76 on the self-assessment (SA) return. The section refers to your “basis period” and asks for start date (box 66); end date (box 67); adjusted profits for 2023/34 (box 73); and total taxable profits for this period (box 76).

Head Aches

That basis period reform will be a headache for sole traders, partners and accountants is old news. The simplest option, where practical, would be to change your accounting period to match the tax year. Where this cannot be done, a wealth of resources can be found on HMRC.

Who is affected?

Only trading businesses subject to income tax are affected by basis period reform– i.e. sole traders and individual partners in a partnership. Companies are not affected and remain subject to the corporation tax rules.

Any business already drawing their accounts up to 31 March or 5 April (or any date in between) will also be unaffected. For the purposes of the tax year basis, 31 March is deemed to be the same as 5 April, so if you have a 31 March year end you can treat your accounting period as the same as the tax year.

Property income is already reported on a tax year basis and should therefore not be affected by the change. The rules which deem 31 March to be the equivalent of 5 April will also apply to property income from 2023/24 onwards.

Does this mean accounts have to be drawn up to 31 March or 5 April?

No – businesses remain free to draw up their accounts to any date they wish.

However, if you choose a date other than 31 March or 5 April, you will have additional work to do each time you come to prepare your self-assessment return and many businesses will therefore find it simpler to adopt a 31 March or 5 April year end.

Calculating profits under the tax year basis

Under the tax year basis, if a business does not draw their accounts to 31 March or 5 April (or a date in between) they will need to time apportion amounts from two sets of accounts to calculate their taxable profits each year.

This apportionment is carried out on a day basis. However, a different time-apportionment can be used provided it is reasonable and applied consistently.

In all cases, the figures to be apportioned are the tax adjusted profit / loss – i.e. after adjusting for non-deductible expenses and capital allowances.

What if my accounts aren’t ready in time?

Depending on the accounting date used by a business, the second set of accounts may not be finalised by the time the relevant self-assessment return has to be filed. This might happen if you have say a 31 December year end.

Where this is the case, you will need to estimate the figure from the second set of accounts and file a provisional figure in your return. That provisional figure will subsequently need to be corrected.

You should ensure your estimate is reasonable, or interest and penalties could arise. You should also keep a record of how you  came to the figure used.

How do I correct provisional figures?

Provisional figures are corrected by amending the original return.

HMRC have indicated that they will allow provisional figures used as a result of basis period reform to be corrected at any time up to the normal amendment deadline, i.e. the first anniversary of the normal filing deadline.

So for example, this would allow you to file the amended return at the same time as preparing the following year’s return.

Which profits are taxed in 2023/24?

In 2023/24 businesses will be taxed on the profits of:

  • The 12 months starting with the end of the basis period for 2022/23 (the ‘standard part’); and
  • The period from the end of the standard part to 5 April 2024 (the ‘transition part’)

For most businesses, the standard part will effectively be the profits they would have brought into account under the current year basis. The transition part will then bring them from the end of that period up to 5 April 2024.

For example, a business with a 31 December year-end will be taxed on the profits of:

  • the year ended 31 December 2023 (the ‘standard part profits’); and
  • the period from 1 January to 5 April 2024 (the ‘transition part profits’).

You will need the results of the year ending 31 December 2024 which will be apportioned to give the transitional profits.

You can deduct any overlap relief from the transitional profits and the balance can then be spread over 5 years.

Tax on transition profits

The transition profits are treated as a separate component of your total income. The tax on them is calculated as if they were the top slice of your income.

Keeping the transitional profits separate from other income reduces the impact on some (but not all) other reliefs and allowances.

What if I start trading in 2023/24?

Businesses which start trading in 2023/24, and do not cease to trade in that tax year, will be taxed on their profits from their date of commencement to 5 April 2024.

Spreading

20% of the transition profits should be brought into account in 2023/24, and a further 20% in each of the following four tax years. You can elect to accelerate the amount of transition profits brought into account in any one tax year. This election must be made on the self-assessment return.

If a business ceases to trade during the spreading period, any remaining transition profits will be brought into account in full in the tax year of cessation.

Effect on capital allowances calculations

None.

How does basis period reform interact with farmers / creative artists averaging?

Transition profits should not be taken into account for the purposes of the averaging rules for farmers and creative artists.

Partnerships

If a partnership does not draw up its accounts to 31 March or 5 April, individual partners subject to income tax will be affected by basis period reform. However, corporate partners will not be affected.

The partnership return will not change under basis period reform and will continue to be based on the accounting period of the partnership. However, the individual partners will have to prepare their self-assessment returns on a tax year basis.

For 2023/24, each individual partner will also have to work out their transition profits, deducting their personal overlap relief figures. They will also make their own choices regarding spreading and any acceleration of spread amounts.

Can I change my accounting date to avoid basis period reform?

Changing accounting date to 31 March or 5 April (or any date in between) will reduce ongoing administrative burdens from April 2024 onwards. In particular, it will remove the need to apportion figures from more than one set of accounts, and the possibility of having to file and correct provisional figures (see above).

However, it will not remove the need to apply the transitional rules in 2023/24, or prevent additional profits being brought into account.

The business can draw up a set of accounts exceeding 18 months in length to effect the change. However, it should be noted that the rule that restricts a period of account to 18 months for capital allowances purposes does still apply, so that affected businesses will be treated as having two separate chargeable periods for capital allowances purposes.

How will basis period reform interact with Making Tax Digital?

Making Tax Digital for Income Tax Self-Assessment (MTD for ITSA) will be introduced from April 2026 for businesses with turnover of £50,000 or more, and from April 2027 for those turning over at least £30,000.

Taxpayers affected will have to submit quarterly updates of their income and expenses to HMRC. These quarterly updates will align with the tax year, and not the accounting period of the business.

No escape!

This is a major change in the taxation of sole traders and partners. There is no escape! It will be the new way going forward so we all just must get used to it.

Certainly, the way forward for most small businesses who are sole traders or partnerships will be to adopt a 31 March year end. It will make your life a lot easier going forward. It will not save you any tax.

 

Questions?

If you have any questions about any of these, you know where to find us. If you prefer, just give me a ring on 07770 738770 or email me at alan.long@thelongpartnership.co.uk.

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