Basis period reform – big changes that need to be understood now
Changes are coming into effect for the taxation of businesses (sole traders and partnerships, but not limited companies) that do not have an accounting year which ends on, or shortly before, the tax year of 5 April. The effect of these changes could lead to a significant amount of extra tax being payable in January 2025.
Where a business’s accounts have historically ended between 31 March and 5 April each year, the new rules will not have any impact.
The new basis period rules will be fully in effect from the 2024/25 tax year, with 2023/24 being a transitional year.
Under the new rules, sole traders and partnerships will need to report their taxable profits on a tax year basis, being the UK fiscal tax year of 6 April to the following 5 April. The 2024/25 tax year therefore covers the period 6 April 2024 to 5 April 2025.
Under the previous rules which applied up to the 2022/23 tax year, sole traders and partnerships would report their taxable profits based on the accounting period which ended during the tax year. This was known as the current year basis rules. Using an example of a business with a year-end of 31 December means that profits for the year ended 31 December 2022 fall within the tax year ended 5 April 2023 and would form the basis of taxable income for the 2022/23 tax year.
Sole traders and partnerships can continue to use an accounting year that is not aligned to the tax year (i.e. not 31 March to 5 April). However, for tax purposes, all sole traders and partnerships must report their taxable profits on a tax year basis from 6 April 2024.
What will happen in the transitional year 2023/24?
The transitional year rules require different calculations dependent on each business’s circumstances.
The trading profits taxed in 2023/24 will comprise two elements (using the example of a 31 December year-end):
- The standard part – profits for the year ended 31 December 2023, the usual profits under current year basis rules, plus;
- The transitional part – profits from the end of the standard part up to the end of the tax year, i.e. 1 January 2024 to 5 April 2024 (based on a pro rata share of the profits for the year ended 31 December 2024), minus unused overlap relief.
Overlap relief relates to income that was taxed twice in the opening years of trading, or a more complex calculation, if trading started before 1996. Depending on how long an individual has been trading this could be significantly lower than the extra income for the period to 5 April 2024. This will be the final chance to use overlap relief so, if it is not claimed in the transitional year, it will be lost.
The transitional part of the 2023/24 taxable profits will be treated as a separate component of total income on the tax calculation to reduce the impact on some benefit and allowances, such as the high-income child benefit charge and the pension annual allowance charge. However, the personal allowance will still be impacted by the increased profits from the transitional part, if total income exceeds £100,000 during the tax year.
The transitional part of the profits will be spread over five tax years but individuals can elect to accelerate this timing. However, an individual will become chargeable in full if they leave the business or cease trading.
For loss-making sole traders and partnerships businesses, although the spreading relief may be restricted, it could prove to be a cash flow advantage as it would be using the loss earlier than what was available under the previous rules. They may also be eligible for the extended carry back loss relief, which allows a loss to be carried back for up to three tax years and receive a refund of income tax paid.
What will happen from 2024/25 onwards?
All sole traders and partnerships will need to report their taxable profits on a tax year basis (year ending between 31 March and 5 April).
Sole traders and partnerships that intend to continue using a non-fiscal accounting year could incur additional costs and administration burdens. This is because additional calculations will be involved to pro-rate the taxable profits reported on the accounts to be in line with the tax year.
For example, a sole trader or partnership with an accounting year end of 30 June will be required to report three months from the accounting year ended 30 June 2024 and nine months from the accounting year end 30 June 2025 on the 2024/25 self-assessment tax return.
Where the profits for the second set of accounts are not available until after the tax return filing deadline, provisional figures should be reported. Once the final figures are available, a corrective tax return should be filed no later than 12 months after the self-assessment filing deadline for the tax year in question.
For example, a sole trader or partnership with an accounting year ended 31 December should apportion two sets of accounts for the 2024/25 self-assessment tax return: nine months from the 31 December 2024 accounts and three months from the 31 December 2025 accounts. The self-assessment filing deadline for the 2024/25 tax year is 31 January 2026, which is only one month after the end of the second accounting period.
The deadline for the payment of the tax liability will remain the same. As such, reasonable estimates should be made to avoid interest and penalty charges on any underpaid tax due to underestimated profits. Detailed guidance has not yet been issued by HMRC on how interest and penalties will be applied, but it is expected.
Using as an example a sole trader who has a year-end of 31 December and is making annual profits of £100,000 and has unused overlap relief of £5,000, their taxable income for the different tax years is shown in the table below.
This is currently the transitional tax year and the first tax payment under the new rules will be payable by 31 January 2025. While the example above shows a modest increase in taxable income, if profits are rising, the impact will be much larger. Now is the time for businesses to be reviewing how they will be impacted by the new rules and plan for the extra tax that will be payable.
If you have any questions about the new new basis period rules, contact our private client tax team.