Date
17 Mar 2022Category
Tax, Corporate Tax, Private Client ServicesThe Government has announced significant changes to the way in which it taxes individuals who are either self-employed or partners in a trading partnership.
The change concerns the so called 'basis period' rules.
At present, a self-employed individual’s profit or loss for a tax year is usually the profit or loss for the year up to the accounting date in the tax year, known as the ‘basis period’. This is called the ‘current year basis’.
The government intends to change from this current year basis to a ‘tax year basis’ with effect from the 2024-25 tax year onwards, so that a self-employed individual’s profit or loss for a tax year will be the profit or loss arising in the tax year itself, regardless of their accounting date.
Transitional rules will apply for 2023-24.
Out with the old…
Following consultation in August 2021, the government is going ahead with these changes to the basis period, despite significant concerns raised by Azets and others.
In fairness, there is a certain amount of good news too. Commencement, cessation and changes of accounting dates will no longer require the complex opening year and cessation rules, as the relevant periods will simply run to and from the end of the tax years respectively.
How will the tax year basis work?
The tax year basis will require businesses to report for the 6 April – 5 April tax year for trading purposes, regardless of their actual period of account. The proposed rules allow the periods to be apportioned by reference to months (“simple apportionment”) if it is reasonable to do so and provided this is applied consistently.
Businesses with non-tax year periods of account would be required to apportion profits or losses across periods of account to adjust their results to the tax year basis.
Example 1 – Rani
Rani is a sole trader. She makes up her accounts to 30 September annually.
On the current year basis, Rani’s basis period for the 2024/25 tax year would be:
Under the tax year basis, the business will report for the 12 months to 31 March 2025, so the apportionment would be:
Pensions and other planning could become harder
We anticipate some significant downsides when it comes to planning due to the basis period reform.
Using Rani as the example, on a 30 September year end it should be possible to know well before the end of the tax year what profits or losses will arise. We are then well-placed to help Rani with planning things like pension contributions and knowing well in advance what her tax liabilities will be.
How does this compare with the new rules? Going forward it will be impossible to know Rani’s result for year ended 30 September 2025 until months after 5 April 2025 at the soonest.
Helping Rani to plan her pension contributions for 2024/25 will be more difficult as a result.
What can Rani do? Going forward many businesses such as Rani’s may need to consider whether to keep their existing accounting dates or change to say a 31 March year end.
What will happen in the transitional year?
For the basis period reform, the transition year will be 2023/24.
In 2023/24, continuing businesses will be taxable on their profits on the current year basis (i.e. for the 12 months to their accounting date in 2023/24, plus the period up to the end of the tax year.
Depending on the accounting date of the business, this could bring up to almost two years’ profits into charge for the year: businesses with 30 April year-ends could be particularly impacted.
This could lead to a significant cashflow disadvantage, arising from an increased tax bill.
Proposals provide for the excess profit to be spread over a period of five tax years to mitigate the cashflow impacts (although individuals can elect to be taxed on the full amount in the transition year).
How will the transitional year work for an existing business?
The basis period for 2023-24 for a trade commencing before 2023-24 (and not ceasing in 2023-24) will start on the day after the end of the basis period for 2022-23 and will end on 5 April 2024.
The basis period will comprise up to three components:
In computing the profits for the 2023-24 transition year, the trader must deduct overlap relief under certain circumstances. Overlap relief that can be deducted is:
Example 2 - Alex
Alex’s profit for the year ended 30 April 2023 is £60,000. Under the current rules his taxable profit for 2023/24 would therefore have been £60,000.
However, under the transitional rules for 2023/24, he will now be taxable on:
Alex estimates that his profit for the year ended 30 April 2024 will be £72,000. He has £5,000 of overlap relief.
Step 1: Alex’s standard part profit is £60,000.
Step 2: 11/12 of £72,000 is £66,000.
Step 3: After deducting overlap relief, Alex’s transition part profit is £61,000.
If Alex elects for spreading not to apply his taxable profit for 2023/24 will therefore be £121,000 (£60,000 plus £61,000).
However, if spreading applies Alex’s taxable profit for 2023/24 will be £72,200 (£60K plus one fifth of £61K).
Want to know more about the basis period reform? Get in touch
There are many reasons why discussing the change of rules with a specialist advisor could benefit you.
It could simply be that you are in Rani’s situation, in Example 1, and want to talk to us about whether changing your accounting date is a good idea.
However, there are lots of other possible reasons. To give just one example, if you are a partner in a trading partnership there may be particular issues for your firm surrounding the basis period reform and change of dates, especially if there are either new or departing partners.
Our specialist tax advisors are on hand to provide proactive advice and guidance as you prepare for these changes to the basis period. For further information or for a more detailed discussion, please speak with your usual Azets contact or a member of our tax team.
