Major Change to basis of Assessment - Basis Period Reform
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Basis period reform represents a major change in how the trading profits of unincorporated businesses (such as sole traders and members of partnerships) are calculated for income tax purposes.
What is changing
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.
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.?The current basis has been with us since 1995 and is advantageous when profits are rising. For example at the extreme if the accounting year end is 30 April then the profits for the year ended 30 April 2022 are assessed in the tax year 2022/23 almost 12 months later. In recent years of course profits have not necessarily been rising so in some cases tax has to be paid on the profits in a good year from income in a bad year.
Basis period reform will end this and 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 the switch over from the current year basis of assessment to this new tax year basis occurs.
Who is (and isn’t) 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.
Operation of the new basis
Under the tax year basis, businesses will be subject to tax on their profits arising in the tax year (i.e. from 6 April to the following 5 April.
If a business has a year-end other than 31 March or 5 April (or any date in between), they will need to apportion amounts from two sets of accounts to calculate their profits for every tax year from 2024/25 onwards. Note that it is not the actual transactions arising in the tax year which are taxed, but rather the relevant proportion of the profit (or loss) based on each set of accounts.
What does this mean in practice?
While ?businesses can still draw up their accounts to any date they wish if they choose a date other than 31 March or 5 April, they will have additional work to do each time the trader / partner comes to prepare their Self-Assessment Tax Return. Many businesses will therefore find it simpler to adopt a 31 March or 5 April year end.
Filing deadlines for income tax self-assessment returns remain the same (i.e. 31 January following the end of the tax year) and there is no change to the frequency or dates for tax payments.
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.
The default is that this apportionment is carried out on a day basis. For example, for the tax year 2024/25, a business with a 30 September year-end will need to apportion:
However, a different time-apportionment (for example weeks or months) 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 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.
For example, as set out above, for 2024-25 a business with a 31 December year-end will need to apportion:
However, it’s not likely that the accounts for the year ended 30 September 2025 will be ready by the 31 January 2026 filing deadline for the 2024/25 return.
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Where this is the case, businesses will need to estimate the figure from the second set of accounts and file a provisional figure in their Return. That provisional figure will subsequently need to be corrected.
The correction of a provisional figure is made via an amendment to the Tax Return.
As a result, the usual provisions relating to amendments will apply. In particular, the enquiry window will be extended, though only in respect of the amended figure, and not the wider Tax Return.
The transitional year - 2023/24
This is a transitional year, in which there is a swap over from the current year basis to the new tax year basis. Specific rules apply in the transitional year, which may result in more than 12 months’ worth of profit being taxed.
In summary, in 2023/24 businesses will be taxed on the profits of:
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 30 September year-end will be taxed on the profits of:
To calculate the transition part profits, the results of the year ending 30 September 2024 will need to be time apportioned.
To alleviate the tax impact of additional profits brought into account, taxpayers can:
How does spreading work?
The default is that 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.
However, it is possible to elect to accelerate the amount of transition profits brought into account in any one tax year. The business can choose any additional amount to bring into account. Any remaining transition profits will then be spread equally over the remaining spreading period (subject to any further election in one of those years).
This ability to accelerate the amount of transition profits brought into account may be particularly useful if a taxpayer is subject to a lower level of tax than usual in any tax year (for example because they have a large expense or lower income that year).
This election must be made on the Self-Assessment Return, and the deadline is one year after the filing date for that return.
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 in scope of MTD ITSA 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.
The introduction of the tax year basis from April 2024 may make alignment with MTD for ITSA quarters easier. However, it should be remembered that, if the business does not have a 31 March or 5 April year-end, then under the tax year basis it is not the transactions actually taking place in the tax year which are subject to tax, but rather the apportioned profits of the relevant accounting ?period.
Summary and Comment
This is a very brief summary of the change and ignores important issues such as overlap profit,? losses, child benefit and? personal allowances to name just a few. Clearly in most instances where this is not currently the case it will make sense to change the accounting date to 31 March or 5 April although this will not solve the issue of the amount to be assessed in 2023/24.
There will be thousands of sole traders and partnerships who will be affected by the change and it is likely that they are not aware of this. The most challenging part will be the need to produce figures or an estimate of profits for the period from the end of the accounting period falling in 2023/24 to 5 April 2024. Many smaller sole traders do not write up their books regularly but only do so nearer the Tax Return date so may have up to 23 months to do. This will cause extra work not only for the taxpayer but for those represented, the taxpayer’s adviser. Clearly software will help the task but there will still be extra work which will incur charges.
Thus the taxpayer is likely to be faced with extra administration, extra fees and extra tax for years to come. There is never a perfect time to bring in a major change but in a cost of living crisis this is certainly “ not a perfect time” ! Despite the fact that the change has obviously been coming there will no doubt be an outcry nearer the time and perhaps a call for the 31 January 2025 Tax Return submission deadline to be postponed for those affected.
There will no doubt be a demand for help from HMRC about this change and this could potentially be a big issue as it is almost impossible to speak to HMRC over the telephone now let alone when a new topic arises. We will have to see what extra resources are available and if the issue will be widely ?publicised.