Basis Period Reform introduced by HM Revenue & Customs (HMRC) will change the timing of when trading profits are taxed. The change applies only to self-employed individuals, which includes partners of businesses. Limited companies are subject to different laws and reporting procedures and are not affected by these changes.
In the 2021 Autumn Budget, the government declared its intention to reform the way trading profits are allocated to tax years for income tax purposes. This decision followed a consultation initiated by HMRC on 20 July 2021, which was later legislated in the Finance Act 2022.
The changes take effect, in full, from the 2024/25 tax year, with transitional rules applying for 2023/24.
The reform seeks to simplify the basis period rules for the self-employed. Under the new system, a business’s taxable profit or loss for the tax year will be the profit or loss that occurs in the same 12-month period, irrespective of its accounting date. This change aims to eliminate the existing complex basis period rules and prevent the creation of overlap relief.
Why the Change?
The existing system, known as the ‘current year basis,’ determines trading profits for the tax year based on the profits of the 12-month accounting period that ends in that tax year. This method can lead to complexities when calculating and recording overlap profits, especially in the opening and closing years of a trading business. In normal circumstances this causes delays in the timing of tax payments to HMRC.
Reform of the basis period rules will make it easier for businesses to understand and comply with tax regulations.
The New System
Starting from the 2024/25 tax year, the ‘tax year basis’ will be introduced where taxable profits will be determined based on profits falling within the tax year: 6th April – 5th April. This is regardless of when an accounting period ends.
This might seem straightforward, but for accounting periods that don’t align with the tax year, it may be problematic, especially when finalising accounts for the tax return deadline.
For example, where a business has a November year end, the tax year basis of 12 months will be based on eight months of profits from the from the first accounts and four months from the second. The second period of accounts would have their year-end only two months prior to the tax return deadline date thus leaving too little time to prepare them. The second part could be estimated, with actuals reported, once known, or the accounting year may be changed.
There will be a transition period. For those with accounting periods not aligned to the tax year (31 March or 5 April only), their profits for 2023/24 will be based on the period from the end of the 2022/23 basis period to 5 April 2024, which will result in a period of greater than 12 months. The transition may result in higher taxable profits in the transition year, however any additional profits, due to the change in rules, may be spread over the next five years to reduce the immediate tax impact.
Not all potential impacts are addressed by these provisions and those affected should seek professional guidance.
Making Tax Digital for Income Tax Self-Assessment (MTD ITSA)
HMRC asserts that Basis Period Reform is essential for the implementation of Making Tax Digital for Income Tax Self-Assessment (MTD ITSA). Under MTD ITSA, businesses will have to send quarterly digital updates to HMRC and provide a digital ‘end of period statement’ to finalise the taxable profit for the tax year. This will be mandated for the self-employed with turnover exceeding £50,000 from 6 April 2026 and will expand to those with turnover over £30,000 from 6 April 2027. Partnerships will follow later at a date yet to be announced.
The reform’s goal is to simplify tax reporting for the vast number of small businesses and self-employed individuals in the UK.
For guidance on Basis Period Reform and what needs to be done to get ready for the transition, contact our tax specialists at James Milne Chartered Accountants.