The way in which HM Revenue & Customs taxes sole traders and partnerships is changing. You may have seen these changes referred to as ‘basis period changes’.
Currently, businesses are taxed on the profits arising for the accounting year ending in a particular tax year. For example, a business with an accounting year-end of 31 December 2022 will be taxed on those profits in the 2022/23 tax year, i.e. the tax year ended 5 April 2023.
However, under the new rules, a business will be taxed on profits arising in the tax year, not the accounting year. This means that the new rules will only affect businesses who have an accounting year end other than 31 March or 5 April, as these businesses are already being taxed on profits arising in the tax year.
From 2024/25 onwards, all businesses will be taxed on profits arising in the tax year, by apportioning the profits for the two accounting years that straddle the tax year in question. Therefore, a business will only ever be taxed on 12 months of profit in any tax year.
The new rules however, come into effect for the 2023/24 tax year, with this being referred to as the ‘transitional year’.
Will the transitional year affect how much tax I pay?
During the transitional year, it is likely that many businesses will be taxed on profits exceeding 12 months.
This is because in the 2023/24 tax year, a business with an accounting year-end other than 31 March or 5 April must recognize two profit elements, the first part being the ‘standard part’ and the second part being the ‘transitional part’.
The standard part will be the profits in the 12 months of the accounting period ending in the 2023/24 tax year.
The transitional part will be the profits arising from the end of the standard part to the 5 April 2024.
For example, if we take a business with a 31 December year-end, during 2023/23 they will be taxed on 12 months of profit arising from 1 January 2023 to 31 December 2023 (the standard part). In addition, they will be taxed on 3 months of profit arising from 1 January 2024 to 5 April 2024 (transitional part), so 15 months in total.
However, any overlap profit must be deducted from the transitional profits at this point, so this may reduce the level of profit being taxed in 2023/24. Overlap profit is an amount that will have been taxed twice in the early years of the business because the accounting year was not 31 March or 5 April – your accountant should have a record of this figure, but it is unlikely to cover the transitional profit because of the likelihood of business growth and the effect of inflation since the early days of the business.
Can I spread transitional profits?
The transitional year allows for the transitional profits to be spread over five tax years. 20% of the transitional profits will be treated as arising in 2023/24, 2024/25, 2025/26 and 2026/27 with the balance being treated as arising in 2027/28. This is the default treatment.
A business can instead elect to treat a specified proportion of additional transitional profit as arising in 2023/24.
How will the basis period changes impact the 2024/25 tax year?
Taking the same example as before, a business with a 31 December year-end will be taxed on the profits arising from 6 April 2024 to 5 April 2025. This will be made up of 9 months of profits from the 31 December 2024 accounting year and 3 months of profits from the 31 December 2025 accounting year.
A problem may arise where a business does not yet know its profits for the 31 December 2025 accounting year, especially in time to submit the Tax Return by the filing deadline of 31 January 2026, as this will only give them one month from the year end to calculate the figures.
In this scenario, a business must provide provisional figures to HMRC and an amended Tax Return would then be submitted once actual figures are known. The alternative would be to alter the accounting date to 31 March which would have the same effect on the tax position as the application of the new rules – this would simplify the tax calculations and remove the need to use provisional figures, but there are other commercial aspects to consider which should be discussed with your accountant.
If you would like to discuss your matter in more detail, please get in touch with our Tax Team.
Author: Louise Berry, Tax Manager
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Date published: 16 May 2023